When it comes to holiday gifts for your kids, it's easy to go with clothes or the latest electronic gadgets. But considering that the Christmas tree will soon be gone and those gifts eventually discarded, wouldn't it be better to have given something that can increase in value and become useful when the time comes to go to college or buy a car or a house?
Getting a gift of stocks or stock mutual funds may not be as exciting to your child as receiving an iPad or the latest fashions, but such gifts can be a great way of fostering interest in investing. That's especially true if the investment involves a company that provides the products or services your child uses and enjoys.
When making gifts to build a college fund or savings for a house, it's important to think about the type of financial account to use. The basic issue with investment accounts for children is that individuals under the age of majority -- either age 18 or age 21, depending on state -- generally aren't permitted to directly own many types of accounts. But adults can open several types to build savings and investing for children.
One of the more effective places to start saving and investing for college costs is a 529 education savings plan. They're popular and widely used: Every state offers at least one 529 savings plan, and nearly $300 billion is invested in almost 15 million 529 accounts.
A 529 is a simple way to save and invest money for your child's education costs. Plus, they provide several benefits:
- Money invested grows tax-deferred, like in an IRA.
- The parent owns the account, and the child is its beneficiary.
- Withdrawals are tax-free when used for qualified education expenses. And if the child doesn't go to college or gets a scholarship, the money can be distributed as taxable income or used to pay education costs of future generations or another family member.
The good thing about these accounts is that anyone can contribute, and they have no income limitations. Also, most states 529 plans have no age limit for when the money must be used.
Another advantage is that parents can make contributions of $14,000 per year without incurring the gift tax. Also allowed is a super-contribution of up to $70,000, which can be treated as if the $14,000 annual contribution was made over five years for gift tax purposes.
If your goal is to get your child interested in learning about investing -- and involved in selecting, buying and selling stocks -- you'll need a different type of account. Consider opening a Uniform Transfers to Minors Act (UTMA) or Uniform Gifts to Minors Act (UGMA) account. The version you use depends on state laws.
Under these accounts, the owner and custodian is an adult (typically a parent), and the child is the beneficial owner. When the child reaches age 18 (or 21, depending on state), the account legally should be converted into sole ownership in the child's name.
Investment income from UGMA/UTMA accounts can have some favorable tax breaks. Assuming the child has no other income and is under age 19 (or under 24 and a full-time student), the first $1,050 of investment income is tax-free. Investment income over that amount but not more than $2,100, is taxed at the child's tax rate (typically 10 percent).
Investment income more than that is included in the parent's taxable income and taxed at the parent's top marginal tax rate, which is the so-called kiddie tax. If the child is 19 and not a student, or 24 regardless of student status, all the income is reported on the child's tax return.
Children who had wage income during the year (such as from a summer job) can open and contribute to a Roth IRA regardless of age. Contributions can be invested in stocks or mutual funds, and distributions after retirement are tax-free. Roth IRAs allow for tax-free withdrawals of contributions and penalty-free withdrawals of earnings when taking money out for the first-time purchase of a home. Annual contributions of 100 percent of earned income, but not to exceed $5,500, to a Roth IRA are allowed.
If your kids have any taxable earnings in 2017 and you want to give them a head start on the future purchase of a home or their retirement savings, help by opening and contributing to their Roth IRA. If you want to make a 2017 contribution to a Roth IRA, keep in mind that you'll have to open and fund the account no later than this year's tax-filing deadline, which is April 16, 2018.
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