Written by Erich M. Imphong, CFP®
One of the biggest regrets for most investors is that they started investing too late. However, if you have children or grandchildren, perhaps you can start them on their way early. Typically, most parents save for their children’s education – as they should! Yet, few consider the possibility of opening a custodial account that can kick-start their children’s investment accounts for adulthood.
The two custodial accounts that achieve this are the Uniform Gifts to Minors Act (UGMA) and the Uniform Transfers to Minors Act (UTMA), which both allow you to save and invest on behalf of a child. In both instances, these accounts transfer over to the child as early as 18 years of age or as stated by state law.
For example, imagine if you invested $1,000 for your child in the Vanguard S&P 500 mutual fund (VFINX) when your child was born in 1987. This amount would have grown 1,575% over the past 28 years to $15,748 – assuming all dividends and distributions were reinvested. Having known the potential for this growth, it is likely that, rather than buying the $5 “GI Joe” toy, you would have opted to squirrel away this $5 for your son down the road (yes, toys should be bought, but in moderation!).
Here is a question that often hits home for working parents that consider gifting to their kids’ investment account: “How much would have $1,000 grown to today if your parents had invested this when you were born?” If you were born in 1960 and the entire amount was invested in the S&P500, that initial balanced would have ballooned to $179,634.03 by the end of 2014! If you continued to contribute to this account from summer jobs and throughout your working career it is likely that initial investment account balance could be well over $1,000,000.
Understanding the value of money and the concept of investing early in life can translate to financial stability later in life. We encourage everyone to teach their children and grandchildren about the financial markets, the excitement of watching a position grow, and the discipline of differentiating between wants and needs.
The most a parent can gift their child in 2015 is $14,000, and the most a married couple can collectively gift their child is $28,000. Funds gifted above this amount will incur a gift tax. Also, unearned income from investments will be subject to a “kiddie tax” on income up to $2,100 in 2015. Income on the first $1000 is not taxed as it is offset by the $1,000 standard deduction. Income on the next $1,100 is taxed at the child’s own income tax rate of 10%. Unearned income above $2,100 will be taxed at their parents’ highest rate. Therefore, it is worth choosing tax efficient investments such as ETF’s, individual equities, and growth oriented mutual funds that don’t generate a lot of income.
Where to Start
The best way to start this process is to open a custodial account. There are certain tax consequences depending how much you plan to invest and how actively the account is managed as indicated in the aforementioned paragraph. Therefore, we recommend you reach out to your advisor or accountant to be sure you are aware how to manage the account in the most efficient way possible. From here, you can educate your son or daughter on their account, where their savings go, and how savings can help meet their long-term goals.
© Geier Asset Management, Inc. May 2015. Erich M. Imphong is the Associate Portfolio Manager of Geier Asset Management, Inc., a Registered Investment Advisor. The above blog reflects the opinions of Mr. Imphong and not necessarily the firm. Any advice given is general in nature and investors must consider their own individual circumstances. Past performance is no indicator of future performance. The firm makes no warranties or representations of any kind relating to the accuracy or timeliness of the information provided.