Advertisement
investing

Best Ways for Kids to Invest Gift Money

Cash gifts to your children can add up to hundreds, even thousands of dollars. Use them to teach the magic of compounding.

Years ago, parents used passbook savings accounts to teach their children about the magic of compound interest. Unless your goal is to teach your son what happens when the Fed lowers interest rates to zero, you’ll want to find other ways to invest the money.

First, though, you’ll need to set up a custodial account under the Uniform Transfers to Minors Act (UTMA) or the Uniform Gifts to Minors Act (UGMA). Brokerage firms and mutual fund companies can provide you with the forms you need. An adult must be appointed custodian, a role that you or your spouse can assume. Once your child reaches the age of majority, usually 18 or 21, he will get full control of the account. If he decides to cash it out and buy a Harley, there’s nothing you can do about it.

Advertisement - Article continues below

You can invest an UTMA/UGMA in just about anything—stocks, mutual funds, exchange-traded funds—as long as you meet the financial institution’s investment minimum. Consider a total stock market index fund, which invests in virtually all publicly traded U.S. companies, suggests Rose Swanger, a certified financial planner in Knoxville, Tenn. TD Ameritrade offers custodial accounts with no investment minimum and hundreds of no-transaction-fee funds. Online stock trades cost just $9.99. Charles Schwab’s custodial account has an investment minimum of $100, and Schwab charges $8.95 to buy and sell stocks online. It also offers a large slate of no-transaction-fee funds.

Advertisement
Advertisement - Article continues below

Watch out for taxes. If your child proves to be an adept investor (or receives a lot more gift money), you could end up paying the “kiddie tax.” Under kiddie-tax rules, the first $1,050 of interest, dividends and capital gains from the account is tax-free; the next $1,050 is taxed at the child’s rate. Earnings above $2,100 are taxed at the parents’ rate. Consider this an opportunity to teach your child about the impact of taxes on investment returns—and the importance of tax-efficient investing. You can minimize the kiddie tax, for example, by avoiding short-term gains, which are taxed at your ordinary income rate. Hold investments for more than a year and you’ll pay long-term capital gains rates—typically 0% to 15%.

Advertisement - Article continues below

Impact on financial aid. When it is time to apply for college, an UTMA/UGMA account will reduce your child’s eligibility for financial aid. The federal financial aid formula counts 20% of a child’s assets (and that includes custodial accounts) when considering how much a family can afford to contribute toward college costs, versus a maximum of 5.64% of parents’ assets.

To avoid that problem, you could invest the money in a custodial 529 college-savings plan. Custodial 529 plans are considered a parental asset under the financial aid formula. If you already have an UTMA/ UGMA, you can convert it to a custodial 529 plan. Because 529 plans accept only cash, you’ll have to sell the investments in the account first. If you have a lot of investment gains, you can lower the tax hit by stretching the conversion over several years, says Joe Hurley, founder of SavingforCollege.com. Once the money is in the 529 plan, gains are tax-free, as long as the money is used for qualified educational expenses.

One possible sticking point: Parents can change beneficiaries in their own 529 plans, but a custodial 529 plan must remain in your child’s name. When your child reaches the age of majority, he will gain control of the account.

Advertisement
Advertisement

Most Popular

7 Surprisingly Valuable Assets for a Happy Retirement
happy retirement

7 Surprisingly Valuable Assets for a Happy Retirement

If you want a long and fulfilling retirement, you need more than money. Here are the most valuable retirement assets to have (besides money), and how …
August 3, 2020
Turning 60 in 2020? Expect Lower Social Security Benefits
Coronavirus and Your Money

Turning 60 in 2020? Expect Lower Social Security Benefits

When you file for Social Security, the amount you receive may be lower.
July 30, 2020
How a Second Stimulus Check Could Differ from Your First One
Tax Breaks

How a Second Stimulus Check Could Differ from Your First One

The HEROES Act, which was passed by the House in May, would authorize a second round of stimulus checks. While the new payments would be similar to th…
July 22, 2020

Recommended

Calculating Taxes on Social Security Benefits
social security

Calculating Taxes on Social Security Benefits

Uncle Sam can tax up to 85% of your Social Security benefits if you have other sources of income, such as earnings from work or withdrawals from tax-d…
August 4, 2020
Understanding Tax Planning
tax planning

Understanding Tax Planning

The importance of tax planning goes beyond keeping cash out of Uncle Sam’s hands. You’re also preparing yourself for a secure retirement. Here are a c…
August 3, 2020
5 Tips to Minimize Your Taxes in Retirement
tax planning

5 Tips to Minimize Your Taxes in Retirement

Don’t pay more than you have to. It all starts with a thorough understanding of the basics of how retirement income is taxed.
August 2, 2020
6 Money-Smart Ways to Spend Your Stimulus Check
Tax Breaks

6 Money-Smart Ways to Spend Your Stimulus Check

If you don't have to use your stimulus check for basic necessities, consider putting the money to work for you. You'll thank yourself later.
July 30, 2020