Most people would likely agree that teaching children about investing is a very important life lesson. However, if you try to have a discussion about stocks and bonds with most children, their eyes will quickly glaze over. How can you get them more involved?
With 401ks replacing pension plans for most workers, many of us are now responsible for our own retirement investing. Companies are generally good about encouraging workers to sign up for 401k plans, but for various reasons they cannot give investment advice. Workers are left to their own devices. Whatever occupation your children choose, the ability to make sensible investment decisions will be a very useful life skill.
Start Them Early
A great way to get kids interested is to give them a real account, with real money. Sit down with them and talk about companies in which they can invest. Even at a young age children are very familiar with brands. Think of companies that they know and like, such as McDonald’s, Disney, Coca Cola, Pepsi, and Apple.
Buy small amounts of one or two stocks and then revisit the account with them periodically. Talk about how much it is worth versus when you first started. Is it up or down? What caused the change? Giving them a real world, hands on experience might just be the trick to piquing their interest. If they are going to make mistakes, better to do so with small amounts than with a 401k later in life.
Setting up the Account
A good way to do this is via a Uniform Transfers to Minors Act (UTMA) account. Under the UTMA provisions, you can open a brokerage account for the benefit of your child and control the account yourself until he/she reaches a certain age. The age depends on the state of residency - in Indiana it is age 21.
It is very important to note that when you put money into a UTMA account it becomes the property of the child, even though the child will not have control over the assets until later. Also, if you put your own money into a minor’s UTMA account, it is subject to the rules surrounding gift taxes. If total gifts to your child within a calendar year are less than the gift tax exclusion of $14,000, you don’t have to worry about the gift tax.
Advantages of a UTMA Account
These accounts are really best suited for investing modest financial amounts given to your child by you or anyone else. While these accounts can be used to transfer large amounts to reduce potential estate tax exposure, there are generally better ways to achieve that goal, namely through the use of trusts.
Another advantage of a UTMA account is taxation. Any investment income in a UTMA - such as dividends, interest, or capital gains - is considered the child's income. However, until the child reaches age 19 (age 24 for full-time college students), the “kiddie tax” applies to all of the child’s unearned income. Under the “kiddie tax” provisions, the first $1,050 of investment income is untaxed and the next $1,050 is taxed at the child's rate. Anything over $2,100 is taxed at the parent's rate.
Some Issues to Consider
As mentioned earlier, anything put into a UTMA account immediately becomes the property of the child and he/she has full control at the designated age. This can be an issue if the child is immature or irresponsible.
Assets in a custodial account could also lower financial aid awards for college. Under current law, any assets owned by a child, including the UTMA, count more heavily than parental assets when determining financial aid eligibility.
Subsequent Steps
When children get older and (hopefully) have jobs, helping them with an IRA account is a great next step. Once a child has earned income they can contribute to a Traditional or Roth IRA account up to the amount of their earned income or $5,500, whichever is less. Generous parents might even fund these accounts or offer a matching contribution for anything the child puts in.
The Roth IRA is an amazing way to save for their distant retirement. All funds in a Roth IRA grow tax-free and can be withdrawn completely tax-free. To give a simplistic example, assume a child contributes $1,000 to a Roth for four years, ages 15 to18. By the time they retire at age 65, an 8% annualized return would mean that $4,000 contribution had grown to nearly $168,000. Not bad!
Summary
Giving children an early introduction to investing can have an enormous impact over their lifetimes. Even if they are not fascinated by the markets, a basic understanding may help them avoid mistakes. That could provide a huge return for a relatively small investment.
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