financial literacy

The Complete Guide for a Kids Investment Plan

May 13, 2022

When thinking about investing for your kids, you may initially just focus on building a savings account for them. The reality is that saving isn’t the same as investing. 

However, because investing tends to be more complicated than simply saving money in a bank account, it can be hard to know where to start — but that’s where we can help.

The first step in investing in your child’s future is to develop a kids investment plan — a master plan detailing your kid's future needs and the types of investments that you’ll use to cover those needs.

In this guide, we’ll discuss how to put together a kids investment plan covering stock investing, college saving, and retirement planning. We’ll also explore the answers to common questions about each one of these topics so that you can get a head start on your kids’ financial future. 

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What is an Investment Plan? 

An investment plan is a comprehensive plan that details an investment strategy to meet investment objectives. 

Investment objectives are financial goals that may vary greatly. Some financial goals may be short-term (e.g., putting together a 20% down payment for a home purchase) or long-term (e.g., saving for education expenses or building a target nest egg for retirement).

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Once you have your investment objectives, you have to consider your risk tolerance, time horizon, and tax considerations to select the investments that will help you achieve those goals.

What is a Good Investment Plan For a Child? 

Child investment plans may vary, but they often center around three major money goals:

Investing for your child’s future expenses

Planning ahead for your child’s future expenses is a great way to open up opportunities and build financial freedom. 

Not living paycheck to paycheck provides your kid peace of mind and empowers them to achieve their full potential.

Investing for a college education

The average college tuition cost for an in-state university stands at $9,349 per year in 2022. When you factor in all college expenses, the total average cost of college jumps to $25,487 per year. The cost of a private college is even higher. 

Fortunately, there are many tax-advantaged savings account options to prepare for future education costs (which we’ll explore more in just a minute).

Investing for retirement

6 in 10 American workers have investing for retirement on the list of their money goals. The earlier that you can get your kid to start investing for retirement, the better. 

Time-in-market is very important — often more so than timing in the market. Giving your child a head start of 18 years of retirement savings can be a huge game-changer.

Let’s break these three parts of a good investment plan down even more and answer some common questions about each of them.

Investing in Your Child’s Future Expenses 

Stocks are an important part of an investment portfolio. The average long-term annual return of stocks is over 10%, as measured by the performance of the S&P 500 market index.

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The S&P 500 tracks the largest 500 publicly-traded companies in the U.S. Instead of picking individual stocks, you can achieve diversification and minimize costs by choosing a low-cost exchange-traded fund (ETF) that tracks the S&P 500.

Can my child invest in individual stocks or ETFs?

Typically, your kid can’t open any type of investment account on their own until they're 18. Kids need an adult to make stock and exchange-traded fund purchases.

How can I invest in stocks or ETFs for my kid?

With a custodial account, you can invest in a wide range of investment products, including stocks, ETFs, and bonds. A custodial account is an investment account with your kid as beneficiary and that you retain control of until she or he reaches age 18 or 21, depending on the state. 

There are two types of custodial accounts:

  • A UGMA custodial account is the most common type of custodial account and allows you to invest money in stocks, bonds, mutual funds, and annuities. 
  • A UTMA custodial account is another type of custodial account that allows you to make the same investments as those in a UGMA custodial account and also in alternative assets (e.g., real estate, jewelry, collectibles).

How much can I invest in UGMA and UTMA accounts?

In 2022, you can contribute to a UGMA/UTMA account up to $16,000 or $32,000 per year as a single filer or joint filer, respectively.

Should I consider investing in crypto for my child’s future?

Investment products evolve over time. For example, ETFs didn’t appear until the 1990s. So, it’s a good idea to future-proof investment portfolios.

Bitcoin and other cryptocurrencies are an option for diversifying child investment plans and ensuring that your child is equipped for the future economy.

Learn everything you need to know about investing in cryptocurrency for children in our guide to crypto for kids.

Investing For a College Education

Building college savings is another common objective for child investment plans. In 2022,  the total average cost of college for a private university is $53,127, including all college expenses.

How can I save for college for my kid?

Here are the three common investment accounts for building college savings:

529 plan

A 529 plan is a common education savings investment account that provides tax advantages to the beneficiary. As long as your kid uses the investment account balance for qualified education expenses, your kids won’t have to pay any tax on this money.

Some 529 plans allow your kid to use the money on a list of colleges. Other 529 plans are “prepaid plans” — money only available for very few or just one college. Another type of 529 prepaid plan is the one that only prepays tuition (prepaid tuition plan). 

Coverdell Education Savings account (Coverdell ESA account)

A Coverdell ESA is another financial vehicle to cover qualified education expenses tax-free.

Unlike a 529 plan, a Coverdell ESA has an income limit for making contributions. Another difference between a 529 plan and a Coverdell ESA is that the latter has a lower contribution limit per year.

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UGMA account

Remember that your kid can use the funds in a custodial UGMA account to pay for education costs — or anything else they’re saving for.

(We mention the UGMA account specifically because the UTMA account option is not available in all 50 states).

What is the difference between UGMA accounts and other education savings plans?

The main difference between UGMA accounts and other education savings plans (529 plans and Coverdell ESA accounts) is that the funds in UGMA accounts are available for all types of expenses (nonqualified expenses).

The funds in 529 plans and Coverdell ESA accounts are only for a list of qualified education expenses.

How much can I invest for my child for a college education?

In 2022, here’s how much you can invest for your child’s education costs per year.

  • UGMA account: $16,000 for a single filer and $32,000 for married joint filers
  • 529 plan: $235,000 to $529,000, depending on state
  • Custodial ROTH IRA: $6,000

What is a good investment strategy for my kid’s future college costs?

A good investment strategy is to cover qualified educational expenses with a 529 plan and/or Coverdell ESA account and nonqualified expenses with a UGMA account.

One of the best money goals that you can teach your child is to minimize student loans. In 2021, the average student loan for a bachelor's degree at a public college was $30,030.

Investing For Your Child’s Retirement 

If your child earns income, he or she can start socking away into a custodial Roth Individual Retirement Account (custodial Roth IRA) and start saving for retirement.

A custodial Roth IRA is a retirement plan that allows your child to build retirement savings with after-tax dollars. Since the contributions to a custodial Roth IRA are made with after-tax dollars, the retirement savings grow tax-free until retirement.

As long as your child doesn’t withdraw the retirement savings until retirement age, your kids won’t have to pay any federal taxes or other types of taxes on the retirement savings.

Why should my kid start early with retirement planning?

The main reason for your kid to start early with retirement planning is the power of compounding.

Let’s assume a teenager earns $4,000 this year working their first job at a fast-food restaurant on weekends. If she were to save $2,000 at a 5% interest rate, that money will have grown to $23,000 over the course of 50 years before retirement.

And the bigger the retirement savings, the more peace of mind during retirement.

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What are the requirements for a custodial Roth IRA?

Your child’s income must be taxable earned income, and the employer needs to report that income to the IRS. 

An example of earned income is income included in a W-2 form. An example of income not eligible for a custodial Roth IRA is interest from an investment or savings account.

How much can my kid save for retirement?

Your kid can contribute up to $6,000 to a custodial ROTH IRA per year in 2022.

Conclusion

A kids investment plan is the foundation of your child's successful financial future.

A complete kids investment plan addresses investing for your child’s future expenses, college education, and retirement. Once you determine your child’s target financial goals, you’ll be better equipped to select the financial vehicle that best meets your unique financial situation.

For most families, opening an account with EarlyBird is a great first step to start investing for your child’s future expenses, college education, and retirement. With the EarlyBird platform, you can build a balanced portfolio of assets like stocks and bonds and have the flexibility of a UGMA account. 

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