There are three primary methods to save and invest for minor children, a custodial account, a 529 plan, or a brokerage account not in the minor’s name.
Goals Drive Everything
First and foremost, before every saving and investing decision you have to reflect on what is your main objective for doing something. In other words, what is the goal. Setting financial goals helps create a clear path for managing resources effectively, ensuring that savings and investments align with one’s priorities and values. By defining these goals, individuals can make more informed decisions that will ultimately lead to greater financial stability and satisfaction.
When it comes to helping save for kids and grandkids start by reflecting on what you want to achieve in both the short and long term as well as what your priorities are.
Examples for saving for minors:
Saving for a specific item – car/future home
College costs
General saving for greater financial independence
Financial and investing education
To transfer wealth
Based on your savings goals you can then have a better understanding of the tradeoffs between different routes to take.
Custodial Brokerage Account
By far the most common example that I encounter for savings and investing for kids under 18 (minors) is through a custodial brokerage account. This was also for many years the preferred method of grand-parents for passing down stock that they had held for many years as well. A move that will share your stock buy will also share your tax basis in the shares and can potentially lead to greater taxes.
A custodial brokerage account is an investment account set up by an adult on behalf of a minor, allowing the child to benefit from investment growth while the adult manages the account until the child reaches legal age. This type of account enables the custodian to invest in a wide range of assets, such as ETFs, bonds, and mutual funds, with the potential for significant long-term growth. Although the investments and their earnings are owned by the minor, the custodian maintains control over the account until the child comes of age, typically 18 - 21 depending on the state. If you are local to Northern Virginia the legal age of majority in Virginia is age 18. Once the minor reaches the legal age, they gain full control of the account and its assets.
Planning Opportunity: In general, we do not favor custodial brokerage accounts for minor children in most cases. This is due to the fact the assets become the kids accounts outright at the age of majority as well as the potential for adverse tax impacts associated with the “kiddie tax”.
Kiddie Tax
The "kiddie tax" is a tax provision that was initially designed to prevent high-income families from shifting investment income to their children in order to benefit from lower tax rates. Under this rule, if a child's unearned income—such as dividends, interest, or capital gains—exceeds a certain threshold, it is taxed at the parent's marginal tax rate rather than the child's lower rate. For tax year 2024, the kiddie tax applies to unearned income over $2,500. This means that the first $2,500 of a child's unearned income is taxed at the child's rate, while any amount above this threshold is taxed at the parent's rate.
529 Savings Option
If the goal you are potentially saving for is college than there is not better option than a 529 savings plan. These plans allow for tax-free investment growth for funds used for higher education costs such as tuition, books, and housing. Parents in DC, Virginia and Maryland can also enjoy a tax deduction on their state returns for certain contributions as well.
While these funds should not be planned to be used for general expenses or a major purchase like a house – there is a recent change that potentially allows for $35,000 of funds to be transferred to a Roth IRA for the child.
This new benefit is incredibly powerful creating flexibility and allowing for a dual savings goal. Saving money for college in a tax -advantaged manner while also having the ability to get a nice chunk of funds into a Roth IRA to start their life.
With an estimate of the minimum in-state college costs likely around $100K – $125K starting to save and invest in a 529 as early as possible can provide great benefit. Certain out of state and private school costs can significantly exceed this amount.
General Brokerage Account
Lastly, if there are concerns that a child or grandchild may not attend college or post high school study, I prefer the option of saving and investing in a general brokerage account in the adult’s name. This can be setup as a new and separate account so you can easily “ear mark” that account for the child’s benefit.
This will get around some of the issues surrounding a custodial account such as the assets becoming there’s outright, the kiddie tax costs, as well as just the overall complexity of a custodial account for a minor.
Planning Opportunity: Another nice benefit of keeping funds in your own name is that if there was ever an emergency or a change in your financial situation you could also repurpose these monies for your own benefit. While still having the option to re-gift again in the future.
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GuidePoint Financial Planning - A Reston Virginia Financial Advisor
Ryan Phillips, CFA, CFP® is the founder of GuidePoint Financial Planning. He is passionate about helping busy families plan, save, and invest for their financial future. Contact him today if you are interested in learning more about the benefits of working with a fee-only (no-commission) financial planner.
All material above is for educational purposes only and is no way a recommendation to buy or sell investment securities. You should always review investment and financial changes with qualified professionals. The data referenced is very short-term in nature and is used for educational means.
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