Investing as a child can be a great way to instill good financial habits and set your child up for future financial success. One of the best ways to get started is through an under account, which can offer great benefits such as tax-deferred growth and early access to funds for important milestones like college or a down payment on a home. In this article, we’ll cover the top 12 under accounts for your child’s first investment.
1. Coverdell Education Savings Account (ESA)
A Coverdell ESA is a tax-advantaged investment account specifically designed to cover expenses related to education, such as tuition, books, and fees. Parents, guardians, or other family members can contribute up to $2,000 per year, and the funds grow tax-free until they’re withdrawn. When funds are withdrawn for qualified education expenses, they’re also tax-free.
2. Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA)
UGMA and UTMA accounts are custodial accounts that allow parents or guardians to hold assets for a minor until they reach the age of majority. These accounts allow for tax-free growth, but withdrawals are ultimately subject to the minor’s income tax rate. Note that once the child is of age, they’re free to use the funds for whatever they choose, which may or may not be education-related.
3. 529 Plan
A 529 plan is another tax-advantaged investment account designed specifically for education expenses. Contributions can be made by anyone, and many states offer tax incentives for contributions. Funds grow tax-free and withdrawals are also tax-free as long as they’re used for qualified education expenses.
4. Roth IRA
While Roth IRAs are typically thought of as retirement accounts, they can also be great investment vehicles for children. Because contributions are made with after-tax dollars, children can withdraw their contributions (but not earnings) at any time without penalty. The funds can also continue to grow tax-free for decades, providing a great head start on retirement savings.
5. Taxable Brokerage Account
A taxable brokerage account may not offer all the tax advantages of other accounts, but it can still be a great way to teach children about the stock market and investing. It also provides great flexibility when it comes to withdrawals, although earnings may be subject to capital gains taxes.
6. Health Savings Account (HSA)
If you have a high-deductible health plan, consider opening an HSA for your child. Funds can be used tax-free for qualified medical expenses, but can also be invested for long-term growth. Once your child reaches age 65, they can withdraw the funds for any reason without penalty, making it a great option for future retirement savings.
7. Savings Account
While a plain old savings account may not offer the same returns as other investment accounts, it can be a great way to teach younger children about money management and saving. Many banks offer special accounts with higher interest rates for children, and they can be a great way for your child to save up for a larger purchase like a car or even a down payment on a home.
8. Custodial IRA
Custodial IRAs are similar to UGMA and UTMA accounts, but are specifically designed for retirement savings. Parents or guardians can invest on behalf of their child and the funds grow tax-free until the account is transferred to the child at age 18 or 21 (depending on state law). Contributions are limited to the lesser of earned income or $6,000 per year as of 2021.
9. Money Market Account
Money market accounts are a type of savings account that typically offer higher interest rates in exchange for a higher minimum balance. They can be a great way for your child to earn a little extra interest while still having easy access to their funds.
10. CD Account
A certificate of deposit (CD) account is a type of savings account that typically offers higher interest rates in exchange for a fixed term commitment. CDs can be great for teaching children about the importance of patience and delayed gratification, as they typically can’t be withdrawn without penalty until the end of the term.
11. Low-Cost Index Fund
If you’re comfortable investing in the stock market, consider a low-cost index fund or exchange-traded fund (ETF). These funds typically track a specific index, such as the SP 500, and offer diversification without the high fees of actively managed mutual funds. Make sure to do your research and only invest in funds that align with your investment goals and risk tolerance.
12. Target-Date Fund
A target-date fund is a type of mutual fund that automatically adjusts its asset allocation over time based on a target retirement date. These funds can be great for hands-off investors who want a set-it-and-forget-it approach to retirement savings. Make sure to choose a fund with a target date that aligns with your child’s expected retirement age.
FAQs
1. What is an under account?
An under account is an investment account that allows a minor to hold assets until they reach the age of majority. This type of account can offer tax advantages and early access to funds for important financial milestones.
2. Are there contribution limits for under accounts?
Yes, there are contribution limits for most types of under accounts. Make sure to do your research and abide by the rules to ensure you don’t incur any penalties.
3. Can funds be withdrawn from under accounts for non-education expenses?
It depends on the type of account. Some accounts, such as Coverdell ESAs and 529 plans, are specifically designed for education expenses and may have penalties for non-education withdrawals. Other accounts, such as UGMA/UTMA and taxable brokerage accounts, allow for more flexibility.
4. What are the tax advantages of under accounts?
Many under accounts offer tax-deferred growth, meaning that you don’t have to pay taxes on any gains until you withdraw the funds. Some accounts, such as Roth IRAs, also offer tax-free withdrawals for certain qualified expenses.
5. Are there risks associated with investing in under accounts?
Like any investment, there is always a risk of losing money in under accounts. Make sure to choose investments that align with your investment goals and risk tolerance, and consider consulting with a financial advisor.
6. Can parents or guardians contribute to an under account on behalf of a child?
Yes, most under accounts allow anyone to contribute on behalf of a minor.
7. Can under accounts be transferred to another person?
It depends on the type of account. Some accounts, such as UGMA/UTMA and custodial IRAs, are automatically transferred to the child at a certain age. Other accounts, such as 529 plans, can be transferred to another eligible family member or rolled over into another 529 plan for the same beneficiary.
8. Can under accounts be used to teach children about investing?
Absolutely! Investing in under accounts can be a great way to teach children about the stock market, the importance of patience and delayed gratification, and the power of compound interest.
9. Can under accounts be used as a form of savings?
Yes, many under accounts can double as a form of savings. Accounts like savings accounts, money market accounts, and CDs offer low-risk ways to earn interest and save for future expenses.
10. How do I choose the best under account for my child?
Choosing the best under account for your child depends on your individual financial situation and goals. Consider factors like tax advantages, fees, investment options, and contribution limits when making your decision. And as always, don’t hesitate to consult with a financial advisor.
Conclusion
Investing in under accounts can be a great way to teach children about money management and set them up for future financial success. With so many great options out there, it’s important to do your research and choose the account that’s right for your family. By starting early and investing regularly, your child can begin to build wealth and achieve their financial goals.
