How to Invest for Your Children's Future

Whether your kids are still crawling around the living room floor or getting ready to graduate from high school, there are plenty of ways you can give them a head start on their financial future.

After all, time and compound growth are on their side—and that’s perfect for kick-starting your children’s retirement savings. Or maybe you just want to help your kids get a college diploma without taking on any debt.

Those are great goals to have! So, give yourself a high five! Here’s a closer look at all the options you have for investing in your child’s or grandchild’s future.

Before You Start Investing for Your Kids

We know you’re eager to dive in, but let’s pump the brakes for just a second. There’s one ground rule you need to follow. Ready? Here it is: Make sure you’re taking care of yourself before you start investing for your children or grandchildren.

Whenever you get on an airplane, one of the first things the flight attendants tell you to do in case of an emergency is to put on your own oxygen mask first before you turn around to help others. The same principle applies here, parents. You need to be completely out of debt (everything except your mortgage) with a fully funded emergency fund (enough to cover 3–6 months of expenses) and investing 15% of your gross income for retirement first. That’s your “oxygen mask”!

Hear us loud and clear here: Do not start investing for your child if you have to stop investing for your own retirement. You need to be prepared financially so you don’t end up depending on your children during your retirement years.

Now that that’s out of the way, let’s take a look at how to invest in your child’s future.

Investing for Your Child’s Future Retirement

Some of you are already wondering how you can give your kids a head start on retirement. That’s great! It’s never too early to save for retirement.

But here again, priorities are important. If your child is earning money, they should use some of it to save for college first before they worry about retirement. Having a few thousand bucks in an IRA isn’t going to do your kids much good if they graduate from college with a bunch of student loan debt hanging around their necks.  

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That being said, you could open a custodial IRA in their name if your teenager is making some money delivering pizzas or mowing lawns. Then, you would manage the account until they’re either 18 or 21 (depending on what state you’re in). With a custodial IRA, you can open a traditional or Roth IRA, but we recommend the Roth IRA. That way, their retirement savings will grow tax-free.

Now, there is a catch: Your child must bring in some kind of earned income in order for you to open an IRA in their name, and allowances don’t count! Plus, they (or you) can’t contribute more than what they make that year. So if your teenager makes $1,000 as a tutor this year, they can’t put more than $1,000 in their custodial IRA. But don’t underestimate the power of small contributions.

Setting just a few dollars aside each month can help your teen get a jump start on their retirement savings and experience the power of compound growth! Assuming an annual return of 11%, here’s how much that compound growth can affect your teen’s retirement if they start investing at age 16, for example:

Age	Money Invested	Account Balance
16	$2,400	$2,524
17	$2,400	$5,341
18	$2,400	$8,484
19	$2,400	$11,991
20	$2,400	$15,903
21–Contributions to the Custodial IRA stop.	$0	$17,743
22	$0	$19,796
30	$0	$47,536
40	$0	$142,093
50	$0	$424,739
60	$0	$1.27 million
Retirement (Age 65)	$0	$2.2 million

Wow! So if your teen invests just $2,400 a year from the time they’re age 16 to 20, they could end up with just over $2 million by the time they’re ready to retire.

Talk about retiring with dignity! Let’s give these numbers some context:

Let’s say you’ve done really well with your money, and you’ve built up a college fund for your 16-year-old daughter. Awesome! Now you want to open up a custodial Roth IRA for her because she is making bank babysitting on the weekends to earn some cash. She wants to put some of her earnings into the Roth IRA, and you agree to “match” up to $100 each month. (Remember, she can’t put in more than she’s making, so she’s bringing in at least $200 a month.) So when your daughter invests $100 into the account, you also put in $100.

That means $2,400 will go into her custodial IRA each year for five years until she turns 21 and the account transfers to her completely. With an average annual rate of return of 11%, she’ll have almost $16,000 in the Roth IRA when she takes over the account.

Like we said above, even if your daughter doesn’t put in another dime, she could have over $2 million by the time she’s ready to retire! And since you chose the Roth IRA, which grows tax-free, she won’t be taxed when she takes money out of the account.

Investing for Your Child’s College Education

Our research shows more than half (53%) of those who took out student loans to pay for school say they regret that choice, and 43% of them even regret going to college altogether.¹

Listen, there’s no law that says parents have to give their kids a paid-for college education. But if that’s important to you and you’re in a position to do it, saving for your kids’ college fund so they can avoid years of student loan payments is the best investment you can make for your kids’ future. They’ll thank you later! Plus, you have some tax-advantaged college savings options similar to your retirement accounts to help you make the most of your savings.

An Education Savings Account (ESA or Coverdell Savings Account) is a great place to start! They’re simple and similar to an IRA, but there are a couple limitations. First, the maximum you can invest in an ESA is $2,000 a year per child. And second, married couples making more than $220,000 a year and single parents bringing in more than $110,000 a year can’t make contributions to an ESA.²

If you want to invest beyond the $2,000 limit or if your income exceeds the ESA income limits, you can also save up for your kid’s college in a 529 plan. This investment account offers tax breaks that allow you to set aside money for qualified educational expenses—things like tuition, books and fees. Sounds like a great option for planning for college, right?

And guess what? Thanks to a major update from the SECURE 2.0 Act, the 529 plan is now a more appealing option! As long as you meet certain requirements, you can roll over any unused money from a 529 into a Roth IRA for the plan’s beneficiary, and you won’t have to pay income taxes or penalties on the rollover.³ That’s great news if you’re worried about putting more into a 529 than your kid will end up needing for college.

Investing for Your Child’s Future Expenses and Experiences

Maybe you’re thinking about investing for things that aren’t too far into the future. After all, your children will go through a lot of important—and expensive—events and milestones in their 20s and 30s.

If you want to save or invest money to help your child cover the cost of a wedding or a down payment on their first house, you’ll want to put that money in an account that’s more accessible than a Roth IRA.

These accounts won’t have the time—or tax breaks—to grow like a Roth account, but your kids will be able to use the money penalty-free when they need it for major life events.

1. Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA) Accounts

If you don’t plan to touch the money in the account for five years or more, you can consider opening a Uniform Gifts to Minors Act (UGMA) or a Uniform Transfers to Minor Act (UTMA) account for your child. They allow you to invest in good growth stock mutual funds. Here are some of the key things you need to know about these accounts:

• Just like with a custodial IRA, UGMA and UTMA accounts are opened in a child’s name and a custodian is named—usually a parent or grandparent. But you can choose anyone to manage the account.
• The custodian will have full control of the account until the child reaches a certain age.
• UGMA and UTMA accounts are often used to save for college—after ESAs and 529s—but the money can be used for anything.
• There are some tax advantages to using UGMA and UTMA accounts. Since they’re in your child’s name, the accounts will be taxed according to their tax bracket. The lower tax rate for children means they’ll pay less in income taxes.
• There are no contribution limits on UGMA and UTMA accounts.

You probably have some thoughts on how you want your kids to spend the money you’re investing for them. Well, keep this important thing in mind: Once your child is old enough to take custody of the account, they can do what they want with the money. This may be fine with you, but make sure you’re teaching your kids good financial habits so they’ll be prepared when they inherit the account.

2. Brokerage Account

If the idea of basically handing your kids a blank check makes you nervous, you can open a brokerage account in your own name and invest over time until you’re ready to gift the money in the account to your kids. Yes, you’ll have to pay capital gains taxes based on your own tax rates. But you’ll also have full control of the account until you decide Junior is mature enough to handle the responsibility of all that cash.

While brokerage accounts don’t have the tax benefits that come with a Roth IRA, they do offer a lot of flexibility. Since there are no contribution limits, you can invest as little or as much as you want—and you can take the money out of the account whenever you like without penalty.  

3. Money Market Account

Technically this isn’t investing, but money market accounts are really great for short-term savings goals (as in five years or less). Money market accounts are very similar to savings accounts, but they come with a slightly higher interest rate and require a higher-than-normal minimum balance.

They’re safer than most traditional investing accounts, but that also means they have lower interest rates—so don’t expect great returns. And just like with a brokerage account, you’ll be in control of when and how your kids receive the money you plan to gift them.

Investing in Your Child: One Last Thing You Should Know

No matter how you plan on investing for your children’s future, it’s important to sit down with your kids when they’re old enough and share your heart behind your gift. Clear communication about the expectations for this money can save you from dealing with family drama around the dinner table during Thanksgiving!

Giving an immature high school or college grad access to thousands of dollars is like handing over the keys to a Ferrari to someone who just passed their driver’s test yesterday. You’re setting them up for a nasty crash. If you want your financial gift to be a blessing and not a curse, make sure you’re teaching your kids and teenagers the value of hard work and responsibility. They should have the character, maturity and wisdom to be a good steward of the financial gifts you’re entrusting to them.

 

This article provides general guidelines about investing topics. Your situation may be unique. To discuss a plan for your situation, connect with a SmartVestor Pro. Ramsey Solutions is a paid, non-client promoter of participating Pros.