Kids and “Their” Money
When putting money aside for your child you have many options and considerations. It can be its own dizzying process. Yet, there are some simple considerations to help you decide what to do.
Paying for college is likely your primary concern, and FAFSA couples right with it. If you’re rich, then financial aid will not be much of a consideration. Although, we all face the question of what is the best thing to do to save for our children’s future?
Start a 529 account is the standard advice these days. Why? The money will grow tax-deferred and not be taxed or penalized at distribution if used for approved college expenses. Many states also give tax credits for money put into 529s. Additionally, the money is still under the parents’ name, so it will not be counted as an asset of the child in the FAFSA needs calculation. There are no limits on the amount deposited, and extended family can conveniently make direct deposits. If the child doesn’t go to college or the money isn’t fully used, it can be transferred to a sibling or other close family member. Hence, a pretty sweet deal, if used for school expenses.
You could start a trust, such as a UGMA or UTMA. This makes the money owned by the child who will receive control of it at 18 to 25 years of age depending on the type of trust and state law. The trust gains will be taxed at the favorable kiddie tax rate and not part of the parents’ taxable income. The money will be available for any use. So, if you want to make sure your child has cash for buying a house, starting a business, traveling the world, or whatever, trusts are a better option than 529s. The big downside is the money will be theirs at the legally required age, and you will no longer have control of it. Also, if they apply for financial aid, the trust will count against their need more than if you kept the money under your name, such as in a 529 account.
What else can you do? If you want to maintain control of the money and still have flexibility for its use, then the plain answer is to start a brokerage account under your name that you designate for the child. It’s still your money, and you can tap into it whenever for whatever. There’s no special tax advantage other than the capital gains rate will likely be lower than your marginal tax rate. That’s the price we pay for total control and flexibility.
I know, you’re saying there must be some other way. Yes, there are lots of other options. Some are expensive, such as a trust that is custom designed by an attorney. Others are not as beneficial, such as a Coverdale account which limits total annual contributions to $2k or bonds that likely won’t keep pace with the inflation of education costs. BUT, here’s one you may not know about:
Roth IRAs can be used for college for two good reasons: (1) Because it’s a retirement account, it is not part of the FAFSA needs calculation, and (2) There is an exception to the early withdrawal penalty for college costs. While withdrawn gains, but not contributions, would be taxed if you’re under 59 ½ years old, with so many of us having children later in life there is a fair likeliness your child will be in college (don’t forget grad school) when you’re past 59 ½. Hence, no tax or penalty on withdrawals for college, or any expense, from this option. Roth IRAs nicely balances monetary control, spending flexibility, tax liability, and investment growth. Regardless of your age, you must plan for it with your Roth, or you could be burning your retirement fund for a child whose income and willingness to support you in old age is uncertain.
Bottomline, as with any investment, you should start early and regularly contribute to maximize growth for your children’s future financial needs.
