Bouncing Bundle of Potential

Hollywood's going gaga over babies -- from Britney's recent delivery to the tummy pooch on Alias's Jennifer Garner. Even boy toy Ashton Kutcher is a new dad. His surprise weekend wedding to Demi netted him several stepkids. (Reportedly, the children -- from Moore's earlier marriage to Bruce Willis -- call him "MOD" for "my other dad.")

I recently suggested that Britney put together an investment portfolio for bouncing baby boy Sean Preston Spears. But there's no reason why parents of kids who aren't born with a silver -- or celluloid -- spoon in their mouth shouldn't do the same.

Before your little angel of perfection learns to speak and develops a raging case of the "I wants," get the rug rat something he or she will really thank you for later (after the tumultuous hormonal teens, that is) -- investments. True, a brokerage statement isn't as fun for show-and-tell at the baby shower as those teensy-weensy Nikes and precious pastel onesies are. But you'll make up for it many times over with all the oohs and ahhs you'll get at Sunrise Village for Seniors when your grown-up bundle of joy picks you up for your regular Sunday drive in a gold-plated convertible hybrid Hummer -- license plate: "TXMUM."

Kinds of kiddie accounts
There are two main issues when it comes to establishing accounts for kids: control and taxes.

1. Mom and dad have all the power.
There are two main kinds of accounts for kids: custodial and guardian. Neither has limits on the amount of money you can set aside for your lucky offspring. A guardian account (sometimes called "in trust for") gives the parent complete ownership. The money in the account is yours to do with as you please. In exchange for complete control, you are also totally responsible for taxes on any earnings on the account.

2. Junior one day gets the keys to the account.
You also control a custodial account, but only until Junior becomes an adult. The benefit of custodial accounts is that any withdrawals (or dividends paid) are taxed at your child's rate. Unless you're Britney's mom, chances are your child's tax rate is significantly lower than yours.

There are two kinds of custodial accounts -- UGMAs and UTMAs, which stand for Uniform Gift to Minors Act and the Uniform Transfers to Minors Act. Both give the parent control over the moola until the child reaches the age of consent. But the parental control period on UTMAs can be extended. Plus, these accounts are designed to be flexible enough to hold more than stocks, cash, or mutual funds. You can put real estate, paintings, patents, and royalties (got that, Sean Preston?) in an UTMA.

Meet your Uncle Sam!
You might be wondering whether baby Ashton can have his very own IRA (individual retirement account). The answer: Only if Ashton has a job. A child must have earned income to be eligible to open an IRA. The Mouseketeers, for example, can choose between a Roth IRA (pay taxes now) or a regular (a.k.a. traditional) IRA (pay taxes later).

The Roth is probably the best choice for a youngster because it allows withdrawals on contributions (not earnings) without tax or penalty. In addition to having an agent and a date to appear on The Tonight Show, your child is subject to the contribution limits of adults (this year, it's $4,000). But the good news is that if he or she earns $8,000 or less a year, no income taxes have to be paid.

A Coverdell Education Savings Account (formerly the "education IRA") is another savings option, but your child is limited on what the money can be used for. The IRS allows you (or doting family and friends) to max out the account at $2,000. You can contribute to this account in addition to state-sponsored or prepaid tuition plans. While Coverdell contributions are not tax-deductible, you can withdraw the moola tax-free for Ashton's college education. If Ashton decides to skip college and go directly to Hollywood, he can transfer the Coverdell account to another family member to use for education expenses, or pay penalties and be forced to withdraw the money when he's 30.

Pick a piggy bank
Opening an account for your child is as easy as picking one for yourself. Virtually every bank and stock brokerage firm (both full-service and discount) offer accounts for kids. The things you shop for are the same no matter what the age of the account holder -- fees, service, product selection. (Here are 10 ways to size 'em up.)

On this chart you can see a side-by-side comparison of IRAs at three discount brokerage firms. And here you can see how we sized up five discount brokers offering regular accounts.

The biggest setback for budding Rockefellers is account minimums. Many mutual fund companies require a certain amount of money for you to even invest in one of their funds. Brokerages, too, may require a minimum account balance to avoid certain fees. But remember, just because Junior doesn't have $1,000 to invest now, that doesn't mean he won't someday soon.

Stocks aren't just for grownups
The fun part is filling your child's coffers. We asked savvy parents how they picked baby's first investments, and here's what they said:

  • Look at the products you use for baby. Take a look at the company behind the formula you feed your bundle of joy and the care products you use. Many of those companies -- like Nestle, Bristol-Myers Squibb (NYSE: BMY  ) , or Pampers maker Procter & Gamble (NYSE: PG  ) -- are publicly traded.
  • Pick companies they've heard of and whose products they use, like Coca-Cola (NYSE: KO  ) or Disney (NYSE: DIS  ) -- even if you can afford only a share or two of each.
  • When your kids are old enough, ask them to get involved in picking companies. (Got any Barbies or American Girl dolls lying around the living room? We've been watching the girl fight at their maker, Mattel (NYSE: MAT  ) , with amusement.)
  • Go ahead and give into peer pressure -- the good kind, that is. Here's some investing advice from teens, to other teens.

No matter which type of account you choose, and no matter what you choose to put in it, the investing education your child gets from this head start will be priceless.

More on kids, money, and watching out for Mom and Dad:

Coca-Cola and Mattel are recommendations of the Motley Fool Inside Value newsletter. To find more great value stocks to give your baby, take a free trial by clicking here.

Dayana Yochimowns none of the companies mentioned in this article. The Fool'sdisclosure policyis written in permanent crayon.


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