How to Invest for Your Kids and Teach Them About Investing

Learning how to invest is similar to learning how to ride a bike. You start with the basics of how to pedal, keep your balance and steadily ride off into the sun. Teaching children the principles of investing is not all that different. By introducing investing fundamentals at an early age, parents can familiarize their kids with financial concepts they can take into adulthood.

Including your kids in conversations about money and investing can help them understand the valuable meaning of saving to invest. These discussions can help increase their financial literacy so they can gradually develop their investing knowledge and ultimately reach their financial goals in the long term.

It is never too early to start learning about investing. Here’s how to get started with educating your kids on how to build a stable financial future from a young age:

— Open a custodial account.

— How parents can invest in their children’s future.

— Grow children’s earnings with a Roth IRA.

— Investing tips for kids.

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Open a Custodial Account

A helpful investing vehicle you and your child can use together to jumpstart their investing education is a custodial account. A custodial account is a long-term investing vehicle that is opened by a parent or other adult on behalf of a minor. The adult controls and makes the financial decisions for the minor in a custodial account.

Even though a custodial account is considered the minor’s asset, the custodian of the account is usually a parent or grandparent and the minor is typically their child or grandchild, who is the beneficiary of the account. When the child reaches the age of 18 to 25, depending on the state, the account is transferred to him or her. Until then, although the assets in the account belong to the child, financial decisions can be made together with the custodian.

The custodian can invest in a variety of assets, such as stocks, bonds and index funds. Custodial accounts are funded by after-tax dollars, and up to $1,150 of the earnings are exempt from federal income tax, with another $1,150 of earnings taxed at the child’s tax rate, which is usually lower than the parent’s tax rate.

Those looking to instill good money skills in their children should start with the basics, recommends Howard Dvorkin, chairman of in Fort Lauderdale, Florida. Dvorkin recounts going to the bank as a young man with his parents and opening a savings account. He explains how he repeated this process with his own kids. “At a very early age, I took my kids to open their savings accounts, where they physically deposited checks. When the account hit a certain balance, I was able to open money market accounts for them to earn more money,” Dvorkin says.

One of the biggest mistakes people make in investing is not having their time horizon in mind, says Timothy McGrath, managing partner of Riverpoint Wealth Management in Chicago. “The rule of thumb I use: If you need the money in five years or less, it should be in a savings, CD (certificate of deposit) or money market account or someplace that it’s liquid. If you need the money in less time than that, there’s a possibility you could invest your money and not get back what you put in initially,” McGrath says.

If children receive monetary gifts from relatives throughout the year, parents may want to set this money aside for a custodial account.

If your child is still young and won’t need this money until they’re 18, it doesn’t have to be in a liquid position. “They can invest that money more aggressively to get better returns,” McGrath explains.

“However, if your child is 14 years old and you decided to save gifts from relatives now to use for college, this money shouldn’t be invested in stocks or bonds,” he says. “Rather, you want a more liquid position, since there’s not enough time to weather a storm.”

[SEE: 10 of the Best Investing Books for Beginners.]

How Parents Can Invest in Their Children’s Future

For parents looking to build up funds for their children’s education, a 529 tax-advantaged account is an optimal investing vehicle for K-12 tuition or college expenses.

A 529 plan, otherwise known as a qualified tuition plan, is a tax-advantaged savings account used for education expenses. Unlike other tax-advantaged savings accounts, a 529 account has no income limits for plan contributions.

Anyone can contribute to a 529 plan, whether it be through monthly contributions or gifts from friends and family.

Withdrawals from a 529 account paid toward qualified education costs are not subject to federal income tax on capital gains from investments. However, 529 funds used for non-educational expenses are bound by federal state and income taxes, along with a 10% federal tax penalty on earnings, and may be subject to state income taxes.

A 529 is more flexible than a traditional savings account. If the original beneficiary decides not to attend a trade or vocational school, college or other post-secondary educational program, the account can be transferred to another child or family member as the new beneficiary.

Earnings from 529 plans grow tax-free over time. The earlier an account is opened for the beneficiary, the more time the funds are invested, which allows more time for earnings potential.

[SEE: 10 Best Low-Cost Index Funds.]

Grow Children’s Earnings Through a Roth IRA

A Roth IRA is a self-directed individual retirement account that provides tax advantages for retirement savings. Account earnings are free from taxes if they are withdrawn after age 59 1/2. Because contributions are made with after-tax money, they can be withdrawn at any age without tax or penalty.

Experts recommend starting to establish a Roth IRA for your dependents as early as you can. You can add any type of investment to a Roth IRA, such as stocks, bonds or index funds. The IRS prohibits insurance and collectibles from being added to Roth IRAs.

“Clients are always saying: ‘I want to help out my kids down the line. What should I do to help them out?’ … One of the best things they can do is a Roth IRA,” McGrath says.

The minor qualifies for a Roth IRA if she has a job and earns annual income.

This strategy works because it allows for decades of compounded growth. “A Roth IRA can show them the true value of compounding. Assume your teen earns $4,000 this year. Have her put $2,000 of those earnings in a Roth IRA,” says Philip Weiss, principal at Apprise Wealth Management in Baltimore.

If she has 50 years until retirement and earns an average return of 5% a year, it will be worth nearly $23,000 when she retires. If it grows at a 7% annualized rate, she will have almost $59,000 in 50 years,” Weiss details.

Investing Tips for Kids

Starting at a young age, children must be taught to save money and that people cannot become wealthy by living beyond their means, regardless of their income bracket.

“I ask my clients: ‘What are you doing to raise financially responsible children? If you want to teach your children anything, you should teach them how to budget and save,'” McGrath says.

If you aren’t sure about finances, start by doing research and steadily become well-versed about personal money management in the near and long term.

“It’s important to instill the value of savings in our youth, as they are our future,” Dvorkin says.

Factoring in some of these financial tools along with your children’s participation is an invaluable learning development for financial literacy and will help them understand that budgeting and saving are what will create a path for a financially successful future.

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