Investing for Your Kids
Who Owns It?
Investing for Your Kids
Once you get an account set up for your child (we'll take you through those steps in a few moments) do you own it, or does your child? That depends on which kind of account you've chosen: a custodian (or custodial) account or a guardian account.
Custodial vs. Guardian accounts
When you open an account for someone other than yourself (your child, in this case), you choose between these two types of accounts. If you have a guardian account, then you own the money. It's yours. You can withdraw it for any reason you want, and you are the one who is liable for the taxes on the earnings. You've got total control, and the price for this is that you pay taxes at your own tax rate. Practically speaking, then, it's basically a way for you to informally earmark funds for your child in an account in your name.
If, on the other hand, you choose a custodial account, you don't own the money -- your child does. As long as your child is a child, you still control the account, but any withdrawals (or dividends, for that matter) are taxed at your child's rate. This is, of course, generally lower than your own. In other words, you've given up some long-term control (as well as ownership), but it's usually a better deal from a tax standpoint.
As we'll see in Step 3 -- The IRA Options, IRA accounts are another alternative that can be viewed through the "who do you want to control it?" lens. With the regular IRA and the Roth IRA, your child is going to own it. With the Education IRA, though, you control the money.
The Two Kinds of Custodial Accounts
There are two kinds of special custodial accounts: The Uniform Gift to Minors Act (UGMA) and the Uniform Transfers to Minors Act (UTMA). Remember, these are accounts that you control, but which are owned by your child. You control them until the age of majority -- generally 18, but it could be as high as 21. In the former -- the UGMA -- you get to give gifts to your kid while you're both alive. (And, of course, that's the best time to enjoy them. Carpe diem.) You can give them money, stocks, life insurance, or annuities.
The UTMA account is similar, except that you have the freedom to maintain control over the money for a longer period of time. Say you're worried that all those wild frat parties will turn your child's head, and dizzy with beer and hazing, he'll do something rash with the money -- so you don't want him to have access to the money while he's still in college. You can postpone distributions to your child until as late as age 25, depending on the state in which you live. In addition, that account can be invested in real estate, royalties, patents, and paintings, should you be fortunate enough to have those assets around in significant quantities. In addition, the UTMA account generally allows the property to be used or spent for broader purposes than support obligations.
Trust and the Trust
There is a way for you to walk a kind of middle ground, if you so choose. If you decide on the UGMA/UTMA route and the account swells to the Gross National Product of several Bahamian states, you may want to hide its existence from your child, at least for a time. Yes, it's a little sneaky, but after all, you're the parent, and you're entitled to exercise some judgment.
The account still belongs to your child, but there is no reason that the account statement has to be delivered to your home -- it could just as easily go to your office. It may be more prudent to teach Junior about investing with a second, smaller account that has less risk of turning his eyes into saucers. You can then introduce the second (larger) account later on, when you're sure he has the proper long-term perspective.
Here, for the sake of pedants, nitpickers, and potential tax evaders, we must inject a word of caution: While you can provide gifts to the children for "extras" (such as the above-mentioned money, stocks, life insurance, or annuities), you are still legally required to support the child, as specified by your state of residency. So you must be careful that the UGMA/UTMA account is not used for general maintenance and support of the child. Not only may you be in violation of local law, you may also lose a tax exemption.
Now, suitably chastened, let's take a look at the IRA options.