Creating an Investment Plan for Your Child

From saving for college to getting a leg up on retirement, creating an investment plan for your child just makes sense. Why? Because when your kids are young, time is on their side in a really big way and it’s only smart to take advantage of it.

In addition, there are several different avenues to consider when setting up an investment plan for your kids. Each one potentially can help set them up for a stronger financial future.

Why Invest for Your Child?

There’s a reason for the cliché, “Time is money.” The power of time combined with money may help generate growth over time.

The technical name for the advantageous combination of time + money is known as compound interest or compound growth. That means: when money earns a bit of interest or investment gains over time, that additional money also grows and the investment can slowly snowball.

Example of Compounding

Here is a simple example: If you invest $1,000, and it earns 5% per year, that’s $50 ($1,000 x 0.05 = $50). So at the end of one year you’d have $1,050.

That’s when the snowball slowly starts to grow: Now that $1,050 also earns 5%, which means the following year you’d have $1,152.50 ($1,050 x 0.05 = $52.50 + $1,050).

And that $1,152.50 would earn 5% the following year… and so on. You get the idea. It’s money earning more money.

That said, there are no guarantees any investment will grow. It’s also possible an investment can lose money. But given enough time, an investment plan you make for your child has time to recover if there are any losses or volatility over the years.

Benefits of Investing for Your Child Early On

There are other benefits to investing for your kids when they’re young. In addition to the potential snowball effect of compounding, you have the ability to set up different types of investment plans for your child to capture that potential long-term growth.

Each type of investment plan or savings account can help provide resources your child may need down the road.

•   You can fund a college or educational savings plan.

•   You can open an IRA for your child (individual retirement account).

•   You can set up a high-yield savings account, or certificate of deposit (CD).

Even small deposits in these accounts can benefit from potential growth over time, helping to secure your child’s financial future in more than one area. And what parent doesn’t want that?

Are Gifts to Children Taxed?

The IRS does have rules about how much money you can give away before you’re subject to something called the gift tax. But before you start worrying if you’ll have to pay a gift tax on the $100 bill you slipped into your niece’s graduation card, it’s important to know that the gift tax generally only affects large gifts.

This is because there is an “annual exclusion” for the gift tax, which means that gifts up to a certain amount are not subject to the gift tax. For 2024, it’s $18,000. If you and your spouse both give money to your child (or anyone), the annual exclusion is $36,000 in 2024.

That means if you’re married you can give financial gifts up to $36,000 in 2024, without needing to report that gift to the IRS and file a gift tax return.

Also, the recipient of the gift, in this case your child, will not owe any tax.

Are There Investment Plans for Children?

Yes, there are a number of investment plans parents can open for kids these days. Depending on your child’s age, you may want to open different accounts at different times. If you have a minor child or children, you would open custodial accounts that you hold in their name until they are legally able to take over the account.

Investing for Younger Kids

One way to seed your child’s investing plan is by opening a custodial brokerage account, established through the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA).

While the assets belong to the minor child until they come of age (18 to 21, depending on the state), they’re managed by a custodian, often the parent. But opening and funding a custodial account can be a way to teach your child the basics of investing and money management.

There are no limits on how much money parents or other relatives can deposit in a custodial account, though contributions over $18,000 per year ($36,000 for married couples) would exceed the gift tax exclusion, and need to be reported to the IRS.

UGMA and UTMA custodial accounts have different rules than, say, 529 plans. Be sure to understand how these accounts work before setting one up.

Investing for Teens

Teenagers who are interested in learning more about money management as well as investing have a couple of options.

•   Some brokerages also offer accounts for minor teens. The money in the account is considered theirs, but these are custodial accounts and the teenager doesn’t take control of the account until they reach the age of majority in their state (either 18 or 21).

These accounts can be supervised by the custodian, who can help the child make trades and learn about investing in a hands-on environment.

•   If your teenager has earned income, from babysitting or lawn mowing, you can also set up a custodial Roth IRA for your child. (If a younger child has earned income, say, from work as a performer, they can also fund a Roth IRA.)

Opening a Roth IRA offers a number of potential benefits for kids: top of the list is that the money they save and invest within the IRA has years to grow, and can provide a tax-free income stream in retirement.

Recommended: Paying for College: A Parents’ Guide

Starting a 529 Savings Plan

Saving for a child’s college education is often top of mind when parents think about planning for their kids’ futures.

A 529 plan is a tax-advantaged savings plan that encourages saving for education costs by offering a few key benefits. In some states you can deduct the amount you contribute to a 529 plan. But even if your state doesn’t allow the tax deduction, the money within a 529 plan grows tax free, and qualified withdrawals are also tax free.

That includes money used to pay for tuition, room and board, lab fees, textbooks, and more. Qualified withdrawals can be used to pay for elementary, secondary, and higher education expenses, as well as qualified loan repayments, and some apprenticeship expenses. (Withdrawals that are used for non-qualified expenses may be subject to taxes and a penalty.)

Though all 50 states sponsor 529 plans you’re not required to invest in the plan that’s offered in your home state — you can shop around to find the plan that’s the best fit for you. You and your child will be able to use the funds to pay for education-related expenses in whichever state they choose.

Recommended: Benefits of Using a 529 College Savings Plan

Other Ways to Invest for Education

Given the benefits of investing for your child’s education, there are additional options to consider.

Prepaid Tuition Plans

A prepaid tuition plan allows you to prepay tuition and fees at certain colleges and universities at today’s prices. Such plans are usually available only at public schools and for in-state students, but some can be converted for use at out-of-state or private colleges.

The main benefit of this plan is that you could save big on the price of college by prepaying before prices go up. One of the main disadvantages is that, with some exceptions, these funds only cover tuition costs (not room and board, for example).

Education Savings Plans

An education savings plan or ESA is similar to a 529 plan, in that the money saved grows tax free and can be withdrawn tax free to pay for qualified educational expenses for elementary, secondary, and higher education.

ESAs, however, come with income caps. Single filers with a modified adjusted gross income (MAGI) over $110,000, and married couples filing jointly who have a MAGI over $220,000 cannot contribute to an ESA.
ESAs also come with contribution limits: You can only contribute up to $2,000 per year, per child, and ESA contributions are only allowed up to the beneficiary’s 18th birthday, unless they’re a special needs student.

And while many states offer a tax deduction for contributing to a 529 plan, that’s not the case with ESA contributions; they are not tax deductible at the federal or the state level.

Investing Your Education Funds

Once you make contributions to an educational account, you can invest your funds. You will likely have a range of investment options to choose from, including mutual funds and exchange-traded funds (ETFs), which vary from state to state.

Many plans also offer the equivalent of age-based target-date funds, which start out with a more aggressive allocation (e.g. more in stocks), and gradually dial back to become more conservative as college approaches.

Depending on your child’s level of interest, this could be an opportunity to have them learn more about the investing process.

Thinking Ahead to Retirement Accounts

It’s worth knowing that as soon as your child is working, you are able to open a custodial Roth IRA, as discussed above. The assets inside the IRA belong to your child, but you have control over investing them until they become an adult.

While it’s possible to open a custodial account for a traditional IRA, most minor children won’t reap the tax benefits of this type of IRA. Most children don’t need tax-deductible contributions to lower their taxable income.

For that reason, it may make more sense to set up a custodial Roth IRA for your child, assuming the child has earned income. A Roth can offer tax-free income in retirement, assuming the withdrawals are qualified.

When to Choose a Savings Account for Your Child

Investing is a long-term proposition. Investing for long periods allows you to take advantage of compounding, and may help you ride out the volatility may occur in the stock market. But sometimes you want a safer place to keep some cash for your child — and that’s when opening a savings account is appropriate.

If you think you’ll need the money you’re saving for your child in the next three to five years, consider putting it in a high-yield savings account, which offers higher interest rates than traditional savings accounts.

You might also want to consider a certificate of deposit (CD), which also offers higher interest rates than traditional saving vehicles. The only catch with CDs is that in exchange for this higher interest rate, you essentially agree to keep your money in the CD for a set amount of time, from a few months to a few years.

While these savings vehicles don’t offer the same high rates of return you might find in the market, they are a less risky option and offer a steady rate of return.

The Takeaway

When considering your long-term goals for your child, having an investing plan might make sense. Whether you want to save for college, help your child get ahead on retirement, or just set up a savings account for your kids, now is the time to start. In fact, the sooner the better, as time can help money grow (just as it helps children grow!).

Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

FAQ

Can a child have an investment account?

A parent or other adult can open a custodial brokerage account for a minor child or a teenager. While the custodian manages the account, the funds belong to the child, who gains control over the account when they reach the age of majority in their state (18 or 21).

What is the best way to invest money for a child?

The best way is to get started sooner rather than later. Perhaps start with one goal — i.e. saving for college — and open a 529 plan. Or, if your child has earned income from a side job, you can open a custodial Roth IRA for them.

What is a good age to start investing as a kid?

When your child shows an interest in investing, or when they have a specific goal, whether that’s at age 7 or 17, that’s when you’ll have a willing participant. Ideally you want to invest when they’re younger, so time can work in your favor.

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