3 Ways to Invest for Your Children to Give Them a Headstart – UTMA, 529, and Roth IRA

Your kid receives money for their Christmas, Bris, Birthday, or whatever occasion comes along. They are 2 years old, so they won’t be asking for it to buy the latest Ricky Martin CD, Blade DVD, or whatever is cool with kids these days. Instead of just stashing this cash in a safe, under the mattress, or even in a regular savings account, you might be thinking about how to help this money grow over time without the complexity of setting up a trust. Luckily, there’s a solution: UTMAs and 529 plans.

What is a UTMA?

A UTMA (Uniform Transfers to Minors Act), and the very similar UGMA, is a custodial investment account for minors. When you open a UTMA, you’re essentially investing your child’s money in a way that they technically own but can’t access until they reach a certain age—usually between 18 and 21, depending on where you live (for example, it’s 21 in Massachusetts).

Setting up a UTMA is straightforward (I suggest looking into Vanguard), and the sooner you start, the more time there is for your child’s money to grow due to compound interest.

What is a 529?

A 529 plan, or a “college savings plan,” is all about saving for future school costs. The government gives you tax breaks on this type of account, so you don’t pay taxes on the money as it grows, as long as it’s used for educational expenses later on. Every state has its own version of a 529 plan, but they all follow the same basic rules.

Starting in 2024, you can move up to $35,000 from a 529 plan into a Roth IRA for your child, under certain conditions. This is perfect if they decide not to go to college or get a scholarship. Plus, you can switch the plan’s beneficiary if needed—maybe even to yourself and you can fulfill your dream of pledging at Alpha Bro Kai at U of Alabama.

Which to Choose? Go for Both! UTMA for Their Money & 529 for Your Contributions

*Remember, everyone’s financial situation is unique. If you’re unsure how these choices might impact your taxes or finances, you should consult with a CPA. I’m simply a personal finance and retirement investing enthusiast who has digested countless books and blogs to craft this straightforward strategy.

1. UTMA for Your Child’s Gifted Money: Set up a UTMA account for each child with Vanguard, Charles Schwab, or Fidelity. These firms offer low-cost index funds, which are great for investing the money long term. For example, with Vanguard, once your child’s account reaches $3,000, you can invest in the VTSAX (Vanguard Total Stock Market Index Fund) and watch the money grow. Once they turn 21, they can use the funds for anything they desire (they’ll need to pay taxes but no penalties). Let’s hope they’re more financially savvy than our generation by then!
   
2. 529 Plans for Your Contributions: If you live in Massachusetts, think about starting a 529 plan with Fidelity’s UFund to get a break on your state taxes. Set up automatic monthly transfers from your checking or savings into the 529, choosing low-cost index funds for the investments. Remember, only invest what you’re comfortable with and utilize online college savings calculators to guide your investment amounts based on estimated future education costs. By the time your child is 18, this investment could provide substantial support for their college or vocational school fees. Plus, there’s an option to roll over up to $35,000 into a Roth IRA for them, offering additional financial flexibility.
   
   Fidelity also gives you a link where relatives or friends can contribute directly to the 529. Is your house covered in toys and someone wants to give them a gift? Send them the 529 link.
   
3. *Bonus: Roth IRA – For Earned Income: If your child earns income (e.g., from a part-time job), consider setting up a Roth IRA for them. You can contribute the lesser of their annual earnings or the yearly IRA limit ($7,000 in 2024). This option requires proof of earned income, such as a pay stub. If you own a business, you can legitimately employ your child and pay them for tasks like using a picture of them for advertising or office cleaning, which can then be invested into their Roth IRA, which they will never have to pay taxes on, offering them a huge head start on retirement savings.
   
4. Trusts – For the Wealthy: If you’re already managing significant wealth, you likely have a CPA and lawyer. Discuss setting up a trust for your children with them to manage and protect larger sums of money. If you’re wealthy and without a CPA, reach out to me—I can help connect you with the right professionals.
   
   I want to clarify that with this blog, I’m not selling anything; I’m just sharing a straightforward strategy that I personally follow. Several friends and relatives know of my obsession with personal finance and retirement investing and have asked me for advice for their kid’s money. So, I decided to put my approach into this blog as a reference for them and anyone else it might help. Clearly, I’m not a financial expert; I’m just a parent eager to secure a bright future for my kids. I believe in the simplicity of index investing and the peace of mind it brings, which I and others like to call “VTSAX and chill.” My goal is to help by sharing what I’ve learned and practiced, hoping it can help you too!