What's the Best Way to Save for My Child's or Grandchild's Future?
My daughter turned 2 at the end of last month. It’s a wonderful age where her personality is blossoming, she’s talking in full sentences, reasoning and negotiating with me, and I feel like I’m meeting a stranger for the first time. There’s so much about her that I don’t know yet and it brings me great joy to discover those things as she is simultaneously discovering the world. Part of my work as a Financial Planner is to quite literally plan for the financial future. This poses as a problem when I consider the many variables and unknowns in the future in general, but more specifically for my daughter.
Will she want to go to college? Will it be relevant in 16 years? If she does want to go to college, will she attend a private school or a public state school? Will she want to go abroad for her education? Will she have a talent for an expensive endeavor that I’m ill prepared to fund? Truly, there’s only so much you can prepare for. So many questions I have for her, but at this point she’s communicated in her best 2- year- old articulation that she’s undecided. This presents my husband and I with the interesting challenge of saving for her future. So, what are our options?
529s and Coverdell Education Savings Funds Here are the vehicles available to you to save specifically for future education costs: 529s vs. Education Savings Accounts (ESA). [i] We decided to open a 529 for our daughter in the case that she does decide that she’d like to pursue higher education. We needed to split the difference for ourselves. If she decides to go to college, it would have been important that we did save into an education specific account as the most tax efficient strategy. However, if she chooses to not pursue higher education, the Secure Act 2.0 made recent revisions that allow us to rollover up to $35,000 from the 529 account into a Roth IRA. This gave us the peace of mind that we have some optionality. Here are the rules around this conversion: [ii]
The account must have been opened for 15 years.
In the year of conversion and subsequent rollovers your child/grandchild must have earned income up to the contribution limit of the Roth IRA.
You may only convert up to the contribution limit per year (For 2023, this contribution limit is $6,500) until you reach $35,000 in the Roth IRA.
Contributions made in the previous 5 years cannot be rolled over.
Uniform Gifts to Minors Act (UGMA)/ Uniform Transfer to Minors Act (UTMA)
UGMA and UTMA accounts are custodial accounts [iii] that adults can set up for minor recipients. They effectively serve as a trust that holds the assets during the recipient’s childhood. You can deposit almost any form of financial product in these accounts, such as cash, stocks or bonds.
These accounts operate very similarly, but here are a few differences. “A UGMA account is limited to purely financial products such as cash, stocks, mutual funds, bonds, other securitized instruments and insurance policies. A UTMA account, on the other hand, can hold any form of property, including real property and real estate. A parent could put their car into a UTMA account if they so choose, or the deed to a family home.
The second key difference between UGMA and UTMA accounts is related to state adoption. All states have adopted the UGMA. On the other hand, Vermont and South Carolina do not allow UTMA accounts. Donors should examine state law carefully, as the specific implementation of both the UGMA and the UTMA can differ from state to state.” [iv]
Here’s some things you want to consider before opening an UTMA or UGMA:
Contributions to this account are irrevocable. Once the funds are deposited, they cannot be withdrawn into an account under your name.
The existence of this account in the minor’s benefit can impact student aid for college.
This account is subject to kiddie tax. [v]
Once the child reaches age of majority transfer is required. You cannot hold onto the account until you think the child is more “responsible” or deserving, etc., you must give full ownership of the account to them.
Custodial Roth IRA A custodial Roth IRA is a retirement tax advantaged account opened on behalf of a minor. [vi] There are some provisions that allow you to withdrawal funds contributed before the retirement age limit, but there is also a 10% early withdrawal penalty for the portion of growth.
To fund a custodial Roth IRA, the minor must have earned income up to the contribution amount. This rule may limit your ability to contribute to this account on their behalf at an earlier age.
Similar to the UGMA and UTMA account, once the child reaches age of majority, transfer is required. This account will help to give your child or grandchild a jumpstart for retirement, but not necessarily for the expenses in between
Opening a Brokerage Account in your name with the unofficial intent to fund future child expenses gives you the flexibility to save for their future without being tied to rules and regulations around minor specific accounts. This may not be the most tax efficient, but may be the simplest way to save for their futures due to the many variables and unknowns.
So what is the most efficient way to save for your children or grandchildren’s’ futures? In short, it depends. We could give you rules of thumb and basic money principles, but we wouldn’t be confident about fulfilling our fiduciary duty to you without understand your full financial picture. If you’d like more insight and guidance on your specific situation, we’d love the opportunity to discuss those details with you. Click "Schedule Now" on the photo below to set up a complimentary introductory call today.