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Creating an Investment Plan for Your Child

By MP Dunleavey · August 11, 2022 · 7 minute read

We’re here to help! First and foremost, SoFi Learn strives to be a beneficial resource to you as you navigate your financial journey. Read more We develop content that covers a variety of financial topics. Sometimes, that content may include information about products, features, or services that SoFi does not provide. We aim to break down complicated concepts, loop you in on the latest trends, and keep you up-to-date on the stuff you can use to help get your money right. Read less

Creating an Investment Plan for Your Child

As a parent, it can be hard to think beyond the day-to-day issues of raising kids, and make time to focus on a financial plan for your children. Fortunately, there are many resources these days to help parents lay the foundation for a solid investment plan for their kids.

From saving for college to — believe it or not — getting a leg up on retirement, there are simple steps parents can take to set their youngster on the path to financial security. And it’s not a cliché to say there’s no time like the present. Why? Because when your kids are young time is on your side, and theirs, in a really big way.

Why Invest for Your Child?

Why create an investment plan for kids? In a word: Time. The power of time combined with money helps to create the kind of financial growth that many adults can only dream of. And as the parent of a young child, or even a teenager, you can harness the power of time to help their money grow.

The technical name for the unbeatable combination of time + money is known as compound interest. That’s a fancy way of saying that when money earns interest, over time that money plus interest earns more interest.

A simple example: If you deposit $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.

And that amount also earns 5%, which means the following year you’d have $1,152.50 ($1,050 x 0.05 = $52.50 + $1,050). Then that amount would earn 5% the following year… and so on. You get the idea. It’s money earning more money.

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 snowball effect of compound interest, you have the ability to set up two or three different investment plans for your child to capture that potential long-term growth.

You can have a college savings plan. You can open an IRA for your child (individual retirement account). And you can set up savings accounts as well.

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

Are There Investment Plans for Children?

Yes, there are a number of investment plans for kids these days. Depending on your child’s age, you may want to open different accounts at different times.

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). Many traditional brokerages offer low- or no-fee custodial accounts, including Ally Bank, Charles Schwab, Merrill Edge, TD Ameritrade, and Vanguard.

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 you place in a custodial account, though parents may still want to keep the $16,000 gift tax exclusion in mind when making contributions each year.

Investing for Teens

Some brokerages also offer accounts for minor teens, under age 18. The teenager can trade and make investment decisions and the parent can monitor the account.

If your teenager has earned income, from babysitting or lawn mowing, you can also set up a custodial Roth IRA for your child. More on retirement options below.

Starting a 529 Savings Plans

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. While contributions to some plans are made with after-tax dollars, the money invested inside the plan can grow and compound tax-free. In some states, you can deduct your 529 contributions.

Withdrawals from the account to cover qualified educational expenses — including tuition, room and board, lab fees, and textbooks — can be made without incurring any tax.

All 50 states, as well as state agencies and educational institutions sponsor 529 plans. You do not have to choose the plan that is offered in your home state — you can shop around to find the plan that’s the best fit for you. Your child will be able to use the funds to pay for college in whichever state they choose.

💡 Need more convincing? Here are the benefits of a 529 College Savings Plan

How to Fund a 529 Plan

First let’s consider the two types of 529 plans. Contributions to either type of 529 plan are considered gifts, so deposits up to $16,000 per person are covered by the annual gift-tax exclusion.

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. Only a few are accepting new applicants.

The main benefit of this plan is that you could save big on the price of college by prepaying before prices go up. The risk is that your child may not attend a participating college or university, so the prepaid tuition plan may pay less than if the beneficiary attended a participating school. Some plans, like the Florida Prepaid Tuition plan, can be used to cover qualified education expenses in or out of state.

Education Savings Plans

The second type of 529 plan is the more common one. It’s an education savings plan, where the money saved grows tax free and can be withdrawn tax free to pay for qualified educational expenses, as noted above.

Contributions are flexible, meaning you can save monthly, quarterly, annually, or deposit a lump sum. Beyond parents making regular payments, 529 plans can be a great way for the extended family to give a meaningful gift on birthdays or holidays.

Contributions are not deductible on the federal level, but many states provide tax benefits for saving in a 529 plan, such as deducting contributions from state income taxes or giving matching grants. Check your local tax laws to see if you qualify.

Investing Your 529 Funds

Once you make contributions, 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 529 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.

How to Spend 529 Funds

You might want to plan to save only the amount you’ll need to cover education costs. Money in the plan can only be used for qualified educational expenses, so you don’t want to overfund the plan and end up having extra money and nothing to spend it on.

If necessary, you could always transfer the account to a second child who can use the money. You could even use it yourself. But non-qualified withdrawals from 529 plans are subject to income tax and a 10% penalty on the earnings portion of the withdrawal.

Thinking Ahead to Retirement Accounts

You can’t have an online retirement account until you have earned income, and your child likely won’t start working until he or she is a teenager at the earliest. However, it’s never too early to start planning for retirement.

It’s worth being aware that as soon as your child is working, you are able to open a custodial 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.

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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 compound interest, and helps you ride out whatever short-term 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 baby or child in the next three to five years, consider putting it in a high-yield savings, which offers higher interest rates than traditional savings accounts. Or an online bank account like SoFi Checking and Savings that earns 2.50% APY.

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.

Working With SoFi Invest

When saving for long-term goals for your child, having an investing plan might make sense. Whether you want to save for college, 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!).

Being a busy parent means you want an easy, secure, and reliable place to start — and SoFi checks all those boxes. When you open a brokerage account it allows you to take a hands-on approach to investing. If your child is old enough to use a mobile device or laptop, they can follow along as you make different choices, whether that’s trading stocks, opening an IRA, or exploring exchange-traded funds (ETFs).

Even better, SoFi members have access to complimentary financial advice from professionals. Set up your child’s financial future today!

Learn more about how to invest your money and put it to work with SoFi Invest.

FAQ

Can a child have an investment account?

A parent or other adult can open a custodial brokerage account for a minor child. While the custodian manages the account, the funds belong to the child. Some brokerages offer youth accounts for teens.

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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