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Set Your Kids Up For Success

Every parent I talk to has a specific idea of how they want to set their kids up for success.


Sometimes it means helping them pay for college or other expenses early in life, and sometimes it means making sure they don’t have anything handed to them.


Most people are somewhere in between, and that’s honestly part of what makes financial planning so fun. 


I’m going to go through some of the options below, but I want to mention one thing that I think often gets glazed over. Make sure your own finances are in good order before saving too much for your kids. Hint: financial planning can help with that.


Also, keep in mind that any time money changes ownership, it’s subject to gifting rules. In 2024, any one person can give any other person $18,000 without filing a gift tax return. This limit doesn’t apply if the giver pays tuition directly for the giftee, which is an important caveat.


Here’s a list of the strategies I’m going to go through:

  • 529 Plans

  • UTMA/UGMA

  • Roth IRA in Child’s Name

  • Roth IRA in Parent’s Name

  • Taxable Account in Parent’s Name


529 Plans:

These are for the people who are fairly certain that their kids are going to go to college or some other school with tuition. One thing that’s nice about 529 plans is that the owner retains control of the money. You may set it up to benefit your child, and they’ll be the beneficiary, but you retain control as the owner of the account and make all decisions about what to do with the money.


529s are often compared to Roth IRAs, because they function somewhat similarly. You put the money in, it grows tax-free, and when you use it for qualified spending, you don’t pay tax on the withdrawals. 


Bonus - when you put the money into the account, you may receive a benefit on your state income tax return.


Now, what is qualified spending? Pretty much anything related to school (with some exceptions).


What if it doesn’t get used for school? Don’t worry, you still have options:

  • Withdraw the money and pay income taxes plus a 10% federal penalty on the gains.

  • Change the beneficiary to another family member.

  • Common options are to change it to your child’s sibling or hang onto the account and name your grandchildren as beneficiaries.

  • Transfer to a Roth IRA in the beneficiary’s name.

  • This one has a lot of rules and is complicated. You should probably involve a professional.


UTMA/UGMAs

This stands for Uniform Transfer/Gifts to Minors Act, but it’s more often just pronounced as “uht-ma” or “uhg-ma.” Minors can’t open investment accounts for themselves, but adults can open accounts on behalf of minors using an UTMA or UGMA.


What’s nice about these accounts is that they’re very flexible. They can be used for anything: car, travel, first home, college, etc. Of course, there are also some downsides.


When you open an UTMA/UGMA for a minor, you’re severing your ties with that money. It truly is a gift to your child, and they will gain full control over the entire account at age 18 or 21, depending on the state. Are you comfortable with how your child may handle that money when they come of age?


These accounts are also taxable - it’s important to be tax-efficient with the investments within accounts. It’s possible to realize gains in the 0% tax bracket to effectively get these accounts to grow tax-free, but it’s an annual process that requires careful tax planning.


Roth IRA in Child’s Name

If you know the benefits of compounding, you know that starting sooner and investing for longer is the key to outsized growth. If you can get that growth tax-free, all the better!


It’s for that reason that I often get questions from parents about starting a Roth IRA for their kids. The one thing they’re usually missing is that in order to fund a Roth IRA, an individual needs earned income.


Business-owners are usually able to find some odd jobs for their kids to help out with and earn some income. This is a popular strategy because it provides a deduction on the parents’ return (generally a higher tax rate) and income on the child’s return - where the child may owe little or no tax at all. Additionally, the amount of wages (up to the Roth IRA contribution limit) can be contributed to a Roth IRA for the child to start building a tax-free asset.


For people who don’t own a business, you can still fund your kids’ Roth IRAs for them as soon as they get a job (even if it’s lawn mowing or babysitting). In either case, you can let your kid keep all of their wages and give them the money to put into their Roth IRA.


You may be thinking, “but wait, minors can’t have their own investment accounts,” and you’d be right - enter the custodial Roth IRA. This functions basically the same way as the UTMA/UGMA accounts, but in Roth form.


Starting a Roth IRA for your kids can be a great thing to do for multiple reasons:

  1. They can always access contributions, tax and penalty-free

  2. If they use funds for a few qualified expenses (including college or a first home purchase), they can use up to $10,000 of earnings in addition to the contributions without incurring taxes or penalties

  3. The longer that money has to compound tax-free, the more it can grow


Roth IRA in Parent’s Name

Maybe you’re not 100% sure how much you want to contribute to your child’s education or other costs, AND you want to save for your own retirement. Using your own Roth IRA may be the answer. Of course, this strategy is all subject to the contribution limits of Roth IRAs.


In this case, the money is always yours. You get to choose whether you want to use it to give to your kids or pay for college.


The benefit of using your own Roth IRA in this way is that you start building tax-free earnings toward your own retirement, but you still have the flexibility to use your contributions before retirement for anything (including college or helping out your kids in other ways).


In order to be successful with this strategy, you need to make sure you’re tracking your Roth IRA contributions. Ask your advisor if they do that for you, but make sure you do it yourself, too.


It’s also SUPER IMPORTANT to make sure you’re not robbing your retirement! Make sure you can afford to use the Roth dollars for your kids instead of yourself.


Taxable Account in Parent’s Name

Of course, if you’re planning to use your retirement accounts yourself, but you still want to set money aside for your child, you can use a taxable investment account. This option is great because there are very few rules. 


You aren’t limited as to how much you put into the account, and you can take the money out at any time for any reason. If you change your mind and decide that you DON’T want to use these funds for your kids, that’s fine - it’s your money. You can change your mind at any time.


There are two downsides. First, any income within the account is taxable to you in the year it occurs, making these less tax-efficient than other options. Second, you’re still subject to the annual gift exclusion set by the IRS for whatever year you end up giving the money to your child.


Conclusion

If you’re looking for a way to efficiently help out your kids, there are plenty of strategies out there. Always feel free to reach out with questions about what’s best for your situation.


 

As always, keep in mind that you don't have to go it alone. I’m Austin Preece, a financial planner in Eau Claire, Wisconsin, and I work virtually with people across the US. Check out my website to see what it's like to work with me and reach out if you have any questions.


If you found this post helpful, help spread the word! Share with friends and family that you think may benefit as well. But remember, this is solely for educational purposes - it's not advice.


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