Starting to invest for a child when they are young can create enormous benefits for them due to the compounding nature of investing.
Two great options for investing for children include a custodial brokerage account and a 529 college savings plan.
A 529 is an investment account that can be set up to pay for education-related expenses. The investment grows tax-deferred and any funds from the account that are used for qualified education expenses can be withdrawn without penalty or taxes.
Qualified education expenses are things like tuition and fees, books and supplies, and some room and board costs. You can also use up to $10,000 per year on K-12 education or student loan repayment.
The annual contribution limits in 2021 are $15,000 per child per person. So if you are married you can contribute up to $30,000 per child per year ($15k from you, $15k from your spouse). Grandparents and others can also contribute to the plan.
Investments in these 529 plans vary by the state and plan you select, but generally you can choose from a variety of mutual funds, ETFs, or target date funds (the funds get less aggressive over time).
Some states offer tax breaks for contributing so if you are in a state that has state income tax, look into your state’s plan first. If you live in a state that does not have state income tax, like me, or you just don’t like your state’s plan, you can open an account in another state’s plan. I have mine in Utah but live in Florida.
Some good resources to find more info are savingforcollege.com and sec.gov/reportspubs/investor-publications/investorpubsintro529htm.html
A custodial brokerage account is another option you can chose that does not have restrictions on using the funds for education expenses. Your child can use the funds for anything they want (which is good and bad at the same time J).
The account is opened for the child but the parent or adult has control until the child is 18, then the money is theirs to continue building up the account or they can use the money.
The capital gains and dividend income is taxed at the child’s tax rate once the annual gains/income amount of $1,100 is reached up to $2,200 and then anything over that is taxed at the guardian’s tax rate.
There are no restrictions on the types of investments you can make for this type of account, but any money that is put in or made on this account is the property of the child, you can’t take it out and spend it on yourself. (no luxury vacations or Teslas). You can open this account at most brokerages (Fidelity, M1 Finance, Schwab, etc.).
To show the power of investing early for your child, take a look at these stats.
According to dividendladder .com, a $100 initial investment at age 0, $100 added a month, with a dividend yield of 3% and capital appreciation of 8% would give your child a balance of $61,339.63 and a yearly dividend income of $1,840.00 at age 18! What a great gift this would be!
While there are many nuances not covered here and please do your own research, I hope this was a good introduction to some of the options of investing for children.