How to Invest for a Baby

I'd like to open an investment account for my 9-month-old son. I have $2,000 to start, and will contribute every year. I already have a 529 savings plan for his education, so this money would be his to do with as he pleases. With luck, my financial education along the way will help him.

Should I open a custodial account so that my wife and I can retain control? Or should I keep it in our name and give it to him as a gift later? I am hoping to earn more than $20,000 in the next 17-plus years and am concerned about how we can retain control and give it to him at an appropriate time, such as when he graduates from college or begins a career.

Also, what are the tax liabilities if we are custodians? And should I look at mutual funds or stocks?

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This query, posted in the Money-Smart Kids forum at Kiplinger.com by a reader with the online handle "gusbdman," drew lots of helpful responses from readers. I'd like to contribute my two cents because I get so many similar queries.

Because "Gus" is not specifically saving for education and already has a 529 account, opening a separate custodial account with a parent as custodian could make sense. Gus's son would get access to the money when he reaches the age of majority. But in most states that is age 21 or even later, so he would likely be out of college or starting a career, as Gus wishes.

With a custodial account, Gus's family would also qualify for tax breaks. In both 2006 and 2007, the first $850 of a child's investment earnings is tax-free, and the next $850 is taxed at the child's rate. Any earnings above that are taxed at the parent's rate until the child turns 18. But that's a lot of tax-advantaged income before the parent's rate kicks in.

If Gus prefers to keep control rather than enjoy tax breaks, he could save in his own name and decide what to do with the money later. In both 2006 and 2007, for example, it's possible to give an individual up to $12,000 (or $24,000 if a spouse joins in the gift) without incurring a gift tax.

But as one reader told Gus, "If you really want your son to learn about investing along the way, seeing his name on the account is pretty powerful."

As to where to invest, mutual funds would be easiest and would give Gus the most diversification for his money. In a recent column, I cited a number of funds with low minimum investments, including Excelsior Value Restructuring ($500 minimum; 800-446-1012).