Investing for kids. Brokerage accounts or 529 plans? We’re going to break down the benefits of these two popular options—so you can decide which is the best fit for your family.
First up, let’s talk about brokerage accounts. These are like your all-purpose investment tool— think of them as the Swiss Army knife of investing. So, why might you want to consider a brokerage account for your little ones? Here are some benefits. Before I get into these, if your child is under age 18, the brokerage account cannot be in their name. It has to be in the name of someone older than 18.
1. Flexibility
Brokerage accounts are incredibly flexible. You can invest in almost anything—stocks, bonds, mutual funds, ETFs, and even more exotic investments like cryptocurrencies or real estate investment trusts (REITs). This flexibility allows your child to explore various sectors and investment types, tailoring their portfolio to their interests and long-term goals. Imagine if your child loves technology; they could invest in tech stocks or funds that focus on emerging tech trends. This type of personalization can make investing feel more engaging and educational.
2. Control and Ownership
One of the greatest benefits of a brokerage account is the sense of ownership it provides. Your child can actively manage their investments, make decisions, and learn firsthand about the market dynamics. This hands-on experience can be invaluable, as it not only teaches financial literacy but also helps them understand the principles of risk and reward. The control extends beyond just the investments themselves; there are no restrictions on how the funds can be used once they reach adulthood. Whether your child wants to start a business, buy a home, or travel the world, the money is theirs to use as they see fit.
3. Tax Benefits
Let’s talk taxes—an aspect that often doesn’t get enough attention. With brokerage accounts, if your child’s investment income remains below a certain threshold, they might benefit from a lower tax rate compared to adults. This is often referred to as the “kiddie tax,” which can mean more of their investment gains stay in their pocket. Additionally, long-term capital gains are typically taxed at a lower rate than short-term gains, so a brokerage account can be a good way to teach your child about different types of income and how they’re taxed. But here’s the kicker. If their earned income is less than $47,025 (single) and $94,050 (MFJ)- their capital gains tax is $0! And actually their gross income can be up to $61,625 (single) and up to $123,250 (MFJ) if they take the standard deduction!
4. Long-Term Growth
Starting to invest early can have a significant impact over the long term. The power of compound interest means that even small, consistent investments can grow substantially over time. For instance, investing $100 a month starting at age 10 can grow into a sizable sum by the time they’re ready to use it in their twenties, thanks to the compounding effect. This long-term growth potential can be an excellent motivator for
children to learn about saving and investing.
Now, let’s shift gears and talk about 529 plans. These are specifically designed for education savings, so they’re a bit more specialized. Here’s what you need to know:
1. Tax Advantages
One of the standout features of a 529 plan is its tax benefits. Contributions are often made with after-tax dollars, but the money grows tax-free, and withdrawals are tax-free as long as they’re used for qualified education expenses. This includes tuition, books, room and board, and even some K-12 expenses in certain states. This tax-free growth and withdrawal can make a huge difference in the amount of money available for education expenses, effectively giving you a boost on your savings.
2. High Contribution Limits
529 plans come with high contribution limits, which can be a big advantage if you’re planning to save a substantial amount for education. Each state has its own limits, but they’re typically quite generous, allowing you to put away a significant sum without hitting any contribution caps too quickly. This feature is especially useful if you’re starting your savings journey late and need to catch up.
3. State-Specific Benefits
Many states offer additional incentives for contributing to a 529 plan. These can include state tax deductions or credits, which can make the plan even more attractive. It’s worth checking your state’s specific benefits, as they can vary widely and provide added financial advantages. States like NY for example, owners can deduct up to $5,000 or $10,000 if married filing jointly).
So, which one should you choose? Well, it really depends on your goals and priorities. If your primary focus is saving for education and you want to take advantage of the tax benefits, a 529 plan is hard to beat. It’s a dedicated tool for education savings with some nice perks along the way.
However, if you’re looking for flexibility and want your child to have ownership and control over their investments, a brokerage account might be the better fit. It allows for a broader range of investments and can be used for various needs, not just education. Plus, it provides a great opportunity for your child to learn about investing and financial management firsthand.
Well what about Financial Aid?
• Asset Consideration: Both the brokerage account AND the 529 are considered a parental asset in the financial aid calculations. For federal financial aid, the value of this account is factored into the Expected Family Contribution (EFC) formula.
• Calculation Impact: The Free Application for Federal Student Aid (FAFSA) assesses up to 5.64% of parental assets, including brokerage accounts, when determining how much a family can contribute towards a student’s education. This means that if you have $10,000 in a brokerage account, up to $564 might be considered as part of your EFC.
• Effect on Aid: The more assets you report, the higher your EFC, which can reduce the amount of need-based financial aid you qualify for.
One type of account we didn’t talk about – and for good reason because I don’t think they make much sense for most people, is the UGMA/UTMA account. This is an investment account held in a minor’s name and will be counted as a student asset for financial aid purposes. This reduces
the financial aid package by 20% of the asset value. So, in this case, a $10,000 student asset means $2,000 less in financial aid vs the $564 less in aid in a brokerage account or 529.
Remember, there’s no one-size-fits-all answer here. Both options have their unique advantages, and the best choice will depend on your individual goals and circumstances.
