We all share the common goal of giving our little ones the best start in life. A great way to open doors for their future is by fostering financial independence from an early age. Now is the ideal time to open an investment account in their name— the exciting part is that you don't need a fortune to kickstart their journey. There are different types of investment accounts designed to helpyour baby start growing her nest egg, if you have some funds ready to go.
“The power of compound growth means you can invest such a small amount when kids are younger, and still have it grow and turn into something very significant when they're older,” explains Chad Willardson, president of Pacific Capital and a father of five. “If you begin investing when they're young, these accounts can multiply significantly just because of the time that you've allowed their money to mature in the markets.”
Of course, if you’re already struggling to make ends meet (which is understandable — have you seen thecost of diapers lately?), you may not be in a position to start putting money aside for your little one just yet. Still, it’s never too soon to learn about your options, so that you can quickly ramp up investment when you’re ready.
At What to Expect, we’ve consulted with financial professionals who not only highlight the best investment accounts for kids but also offer more insight into the benefits of investing early.
Why it’s important to invest for your kids
Aside from the already-discussed power of compound interest, there are a number of other reasons that you should consider investing for your children.
Your kids can learn alongside you. If your children are old enough (around age 6), talk to them about the steps you’re taking to help save for their future. Consider explaining the basics of a bank account or an investment account, and how their money can grow over time.
You’re setting a positive example. “Your kids are observing your money habits just by living with you and listening to the way you talk about it and watching how you spend,” Willardson says. “So the more you can actually involve them and include them in conversations about money, the better prepared they’ll be to be successful.”
You’ll be able to start saving for their future. With college costs climbing, starting early is key. Not only will you benefit from compounding interest, but some accounts are structured in a way that they can provide special tax advantages if you plan to use the funds for school, helping you keep more of your nest egg.
How we chose the best investment accounts
To learn about the different types of investment accounts that could make sense for parents looking to save on their children’s behalf, we considered the following:
- Insight from four financial professionals
- Kimberly Bridges, Ph.D., senior vice president at BOK Financial
- Jacob Jackson, private wealth officer for BOK Financial
- Jim Penna, senior manager of retirement services and investment strategy at VectorVest
- Chad Willardson, president of Pacific Capital, co-host of the “Smart Money Parenting” podcast, and co-founder of Gravy Stack, a financial education and banking app for kids
- The criteria for opening each account, making sure it was possible to set up this account on behalf of a minor and when their independent access could begin
- Tax incentives and exemptions for earnings and withdrawals, ensuring they make sense for a custodial arrangement
- Flexibility in how the funds are ultimately used
The best investment accounts for kids
With those factors in mind, we highlight which accounts may be worth taking a closer look at.
1. Best for education: 529 savings plan
A 529 savings plan offers key tax incentives to start saving for your children’s education. As long as you use the money toward qualifying educational expenses, you won’t have to pay taxes on distributions, which can result in major savings. In some states, your contributions toward a 529 plan can even be deducted on your state income tax return.
Thanks to the Tax Cuts and Jobs Act of 2017, qualifying expenses now extend to tuition for K-12 education; you can use up to $10,000 per year from your 529 savings for these expenses. There is no limit on how much you can withdraw to use for college expenses.
What to look out for: If you don’t end up using your 529 savings plan distributions for qualified educational expenses, you may be liable for taxes and a 10% penalty on your earnings, so you want to be careful about how much you put in—however, some potential exceptions could allow you to waive the penalty:
If your child gets a scholarship, you may be able to withdraw up to the amount of the scholarship penalty-free.
If your child attends a U.S. military academy, you may be able to withdraw up to the amount of the value of the education penalty-free.
If the plan has been open for more than 15 years, you may be able to roll up to $35,000 of unused funds into a Roth IRA account.
What the professionals say: “The beauty of a 529 plan lies in the flexibility it provides,” says Bridges. “Since you maintain ownership until the child reaches the age of majority — usually 18 or 21, depending on your state — you can change the beneficiary of the plan should the child not need the funds, including naming yourself or your spouse as beneficiary.”
2. Best for versatility: Uniform Gifts to Minors Act (UGMA) Accounts
A UGMA account lets you invest in a wide variety of different assets on behalf of your child, such as mutual funds, stocks, bonds and CDs. They can access and use the funds as soon as they come of age — and unlike a 529, there are no rules about what they can use them for. The major benefit of a UGMA account is that the funds will be taxed at your child’s applicable tax rate — which is likely to be relatively low — instead of your own. And even though you don’t have to designate the money to be used for something specific, some parents will let their children know that their intention is for their child to use the funds toward a wedding or a first house or another specific milestone.
What to look out for: You don’t actually have control over what your child uses the money for once they can access the account, so it’s up to them to follow through on your plans.
What the professionals say:“You must remember that the cash you put in stays there," says Penna. "It now belongs to the child. And once that child becomes an adult, either 18 or 21 depending on where you live, that child gets full control of the account. So, you better teach them well and prepare them for that responsibility when they are of age."
3. Best for retirement: Custodial Roth IRA
As far-off as it may seem, it’s not too early to start thinking about your child’s retirement if you want them to benefit from certain tax advantages. As soon as your child starts earning money of their own, you can open a Custodial Roth IRA on their behalf. This allows them to contribute up to $7,000 of their income per year (as of 2024), with funds growing tax-free — so they won’t have to pay any taxes on their earnings when they’re older, as long as they meet the rules for qualified distributions. As the parent or guardian, you’ll have ownership of the account while they’re a minor, but once they reach 18 the account will be under their control.
What to look out for:To take advantage of tax-free distributions, your child will have to wait until they reach the qualifying age to withdraw — currently 59 and a half. However, there are certain exceptions. For example, they may be able to withdraw some funds early and without a penalty for the purpose of purchasing a first home.
What the professionals say:“Custodial Roth IRA’s are great for kids who have a summer job: babysitting, mowing the yard, etc.,” says Jackson.
4. Best for teaching how to save: Custodial savings accounts
Opening a savings account for your minor child could be thought of as the standard, “vanilla” way to save. The process is typically straightforward: you’ll open a bank account in your child’s name, with a designated parent or guardian serving as the custodian. Then, you’ll be able to deposit those birthday checks from Grandma straight into their account for safekeeping, so that they’ll be able to use the money when they’re older and really need it. For the sake of convenience, you may want to open your child’s bank account at the same bank you use, or you could shop around to see which banks offer fee-free options or other benefits for kids.
What to look out for: In a high-inflation environment, your child may not earn enough money through a basic savings account to keep up with inflation.
What the professionals say:“Savings accounts establish the habit of saving early. These accounts are easy to open and do have the opportunity to earn interest,” Jackson says.
5. Best for teaching how to invest: Custodial brokerage account
While minor children aren’t eligible for their own brokerage account to buy and sell stocks, ETFs or mutual funds, you can open one and start investing on their behalf as a custodian.
What to look out for: Don’t forget that when it comes to the stock market, what goes up can also come down; your investment has the potential to rise or decline. Since it will likely be a long time before your child actually needs to withdraw their investment, though, time is on their side.
What the professionals say:As soon as your child is old enough, consider letting them get in the “driver’s seat,” showing them how to find and purchase stocks. “Get them the experience; let them make mistakes. I think it's going to be a lot better when they're doing it with small amounts of money than if they're 50 or 60 doing large amounts of money,” says Willardson.
Get started today
As a parent, financial stability is one of the greatest gifts you can give. Before you know it, your child will be ready to conquer the world on their own — and some savings to start out with can undoubtedly give them a better chance to succeed in achieving their dreams.
You’ll also teach them lessons that will last a lifetime.“When it comes to investing, successful investing comes through persistence, patience and delayed gratification. So if you can teach your kid that skill, that'll help them in many areas of their life,” says Willardson.
So start saving; no amount is too small, especially if you start now and have the benefit of compounding interest on your side. Your child will thank you!
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