Planning your Kids future

Investing in a child’s future is a strategic and impactful decision that parents can make to secure both their own and their children’s long-term financial well-being. In the face of rising education costs, increasing living expenses, and an increasingly complex economic environment, early investment offers a strong foundation for future financial stability and opportunity. By starting early, parents can take advantage of compound interest, enabling even modest contributions to grow substantially over time.

A well-planned investment approach also allows families to prepare for major life expenses—such as higher education, homeownership, or entrepreneurial endeavors—in a structured and tax-efficient way. Beyond financial preparation, implementing tÅhoughtful investment strategies fosters financial literacy. Involving children in the process helps them develop an understanding of saving, patience, risk management, and the principles of long-term investing.

Effective investment strategies for children should emphasize long-term growth, tax efficiency, and education. Parents should begin by choosing the most appropriate type of account based on their objectives—such as a 529 plan for education savings, a custodial account (UGMA/UTMA) for general-purpose investing, or a custodial Roth IRA for children with earned income. Building the investment around low-cost, diversified index funds or ETFs provides broad market exposure while minimizing risk. Automating regular contributions promotes consistency and encourages the habit of disciplined investing. Finally, by involving children in reviewing their investment portfolio, parents can instill essential financial skills and prepare them for a lifetime of informed, responsible financial decision-making.

STEPS TOWARDS SECURE FINANCIAL FUTURE

1. Choose the Right Investment Accounts

Choosing between various types of accounts is the first step towards securing your child’s future. The various types of accounts available are -

• Custodial Accounts (UGMA/UTMA) – This is opened under the child's name and managed by the parent.This account is for any purpose benefiting the child (not just education). This account becomes fully the child’s at the age of majority(usually 18 or 21 depending on the state). Taxable: The first ~$1,300 of unearned income is tax-free the next ~$1,300 is taxed at child’s rate and beyond that its taxed at the parent’s rate (kiddie tax).
• 529 College Savings Plan – This plan is Tax-advantaged for education expenses. The funds grow tax-free and can be withdrawn tax-free if used for qualified expenses. Some states offer tax deductionsor credits for contributions.
• Custodial Roth IRA – This is for kids with earned income(e.g., from a job)..The growth is tax-free, and withdrawals in retirement are also tax-free. Its considered an excellent long-term tool — even $1,000 invested as a teen can grow significantly by retirement.
• ABLE Accounts – This account is specifically for specially abled children. It allows up to $18,000/year (2024 limit) to be saved without affecting SSI/Medicaid.
  

2. Define Investment Goals

Parents should begin by clearly defining the purpose of the investment. Key questions to consider include:

• Is the money intended for college, a first car, or long-term wealth building?
• What level of risk is appropriate based on the investment timeline?

Once the goal and time horizon are established, parents can select the most suitable investment vehicle—one that aligns with their financial objectives and offers the greatest tax advantages. Below is a guide to choosing the appropriate account based on specific goals:

Selecting the right account type ensures that both the parent and child benefit from a tailored, efficient investment strategy that supports long-term financial success.

3. Build a Simple, Diversified Portfolio

Parents should also consider building a diversified investment portfolio to help navigate fluctuations in the market and broader economy. Maintaining simplicity and keeping investment fees low are key principles, especially for long-term strategies. Some effective options include:

• Index Funds(e.g., VTI, S&P 500 Index): Offer broad market exposure with low fees.
• ETFs (Exchange-Traded Funds): Ideal for passive investors due to their simplicity and cost-efficiency.
• Target-Date Funds: Automatically adjust the asset allocation based on the child’s age or expected college enrollment year.

A well-diversified portfolio spreads risk across various assets, reducing the impact of market volatility and enhancing the potential for steady, long-term growth.

4. Monitor and Adjust Over Time

It is important to regularly monitor and rebalance the investment portfolio—ideally on an annual basis—to ensure it remains aligned with the family's financial goals. As the child approaches key milestones, such as entering college, adjustments should be made to gradually reduce risk by shifting the allocation toward more conservative assets, such as bonds. This process not only helps protect the accumulated savings but also offers a valuable opportunity for parents to involve their child in reviewing the portfolio’s performance, fostering an ongoing understanding of investment principles and responsible financial management.

5. Teach Financial Literacy Early

Instilling financial literacy in children from a young age is a crucial component of preparing them for lifelong financial independence and responsibility. While managing their investments on their behalf, parents should actively involve children in age-appropriate discussions about money, saving, and investing. This not only demystifies financial concepts but also helps build confidence in making informed decisions.

There are also a variety of tools available—such as kid-friendly banking and investing apps (e.g., Greenlight, Fidelity Youth, or BusyKid), financial games, books, and online resources—that make learning engaging and practical. Additionally, real-life experiences like budgeting allowance, making a purchase decision, or contributing to a savings goal can reinforce good financial habits. Older kids can also contribute in helping and choosing which companies or funds to invest in.

6. Knowledge of Kiddie Tax

Parents investing on behalf of their children should be aware of the Kiddie Tax, a set of IRS rules designed to prevent families from avoiding taxes by shifting unearned income—such as dividends, interest, and capital gains—to their children, who typically fall into lower tax brackets. Under the Kiddie Tax rules, a portion of a child’s unearned income may be taxed at the parent’s marginal tax rate rather than the child’s lower rate.

As of 2024, the first $1,300 of a child's unearned income is tax-free, and the next $1,300 is taxed at the child's rate. However, any unearned income above $2,600 is subject to taxation at the parent’s rate. These rules apply to children under age 18, or under age 24 if they are full-time students and do not earn enough to support themselves.

Understanding and planning around the Kiddie Tax is essential for optimizing a child's investment strategy. Parents may want to consider tax-efficient investments, such as growth-focused ETFs or index funds with low dividend yields, or prioritize contributions to 529 plans or custodial Roth IRAs, which offer tax advantages and are not subject to the Kiddie Tax. Consulting a tax professional can help ensure that investment decisions align with both the family’s financial goals and current tax regulations.

7. Legal & Estate Planning

Legal and estate planning is an often-overlooked but critical aspect of managing investments and assets for children. For most families, estate planning for children begins with establishing a will that names a guardian for the child and outlines how their assets should be managed. If significant investments or inheritance are involved, parents may consider setting up a trust, such as a revocable living trust or a minor's trust, to control how and when the child can access the funds. Trusts offer greater flexibility than custodial accounts and can delay asset transfers beyond the age of majority, reducing the risk of financial mismanagement.

Additionally parents should consider adding a Transfer on Death (TOD) designation on investment accounts. Parents who open custodial accounts (UGMA/UTMA) should be aware that these accounts legally transfer to the child at age 18 or 21, depending on the state. It is also important to include powers of attorney, health care directives, and a letter of intent in the overall estate plan, especially if the child has special needs. In such cases, establishing a Special Needs Trust (SNT) can ensure the child receives proper care and financial support without jeopardizing eligibility for government benefits.

Engaging with an estate planning attorney can help parents navigate complex decisions, tailor plans to their family's unique needs, and ensure compliance with state and federal laws.