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Q: I recently had a child and I would like to invest money for her in something other than a 529 account. I want her to be able to use the money for anything she wants, not just for college. — Allison
A: If you plan to do some serious savings, it’s hard to beat the tax savings, parental control, high contribution limits, and financial aid treatment of a tax-advantaged 529 college savings plan, says Mike Slud, a chartered financial analyst and a managing director in Convergent Wealth Advisors’ Washington, D.C. office.
That said, there’s something to be said for setting aside some flexible funds to cover wants and needs beyond school, whether it’s a dream summer camp, a first home, or a budding business.
If flexibility is truly your priority, the easiest option is to set up a custodial brokerage account in your child’s name. If you have a brokerage account of your own, consider keeping your business in one place. If you’re starting from scratch, you might want to take a look at such low-cost brokerages as Charles Schwab, E*Trade, or TD Ameritrade.
Read Next: What’s the Best 529 Plan for Me?
These accounts, which are also known as Uniform Gift to Minors or Uniform Transfer to Minors (UGMA/UTMA), let you set aside up to $14,000 a year ($28,000 for spouses filing jointly) in your child’s name, sans gift tax. And while you won’t get the same tax benefits as a 529 plan, there are some tax breaks for kids.
The so-called Kiddie Tax doesn’t kick in until your child’s investment income exceeds $2,000, with the first $1,000 tax free and the second $1,000 taxed at the child’s rate. Anything after that is taxed at your marginal tax rate, until your child takes over the account.
Once you open an account, you can make your investment strategy as simple or as complicated as you’d like. Slud recommends starting with an index mutual or exchange-traded fund that tracks a diversified benchmark, such as the S&P 500 index of blue chip U.S. stocks.
If you go with a mutual fund, you’ll likely need to meet a minimum investment requirement, which typically ranges from $100 to $3,000, depending on the fund. Because ETFs trade like stocks, there are no pre-set minimums, but you may be hit with brokerage commissions.
You’ll probably want to stick with a diversified fund to start, but down the road by all means to let your child pick out one or two stocks for his or her account. (One share is plenty.) “There is a tremendous educational element there,” says Slud, who notes that middle school is typically a good time to get your child involved.
While a custodial brokerage account offers maximum flexibility, both in terms of how you invest and how your child ultimately uses the money, that cuts both ways. “When a child reaches age of ‘majority,’ which is age 21 in most states, they can do anything they want with it,” says Slud. “Depending on how much you’ve contributed and who the portfolio has done, that can be substantial.”
Another drawback of investing in a custodial account is its impact on financial aid. Whereas 529 plan savings have a minimal effect on financial aid, the full value of a custodial account is considered fair game for financial aid purposes.
That likely won’t be an issue if your child uses the funds before college or if you’re certain that financial aid isn’t in the cards. Still, it’s all the more reason to think twice about plowing money into a custodial account.
Now, there are other ways to save for your kids outside of a 529 plan.
You could always tuck the money into your own taxable account and earmark it for your child. There are some practical benefits to going this route, even if some of the sentiment is lost.
There are also trusts and cash-value life insurance policies designed to help parents save for their kids. Of course, these come with additional costs and complexities.
And for most parents, the best bet is to keep it simple.
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