Want to Invest Money for Your Child? Consider a Custodial Account

Many parents want to set their kids up for financial success. One of the best ways to do that is to invest money on their behalf. Although there are many different investment accounts to choose from, consider opening a custodial account for your child.
 
What is a custodial account?
 
A custodial account is a type of account you can open to invest money on your child’s behalf. Technically speaking, there are two main types: A UGMA (Uniform Gift to Minors Act) and a UTMA (Uniform Transfer to Minors Act). With a UGMA, you can invest money in securities like stocks and bonds on their behalf. With a UTMA, you can invest in securities like stocks and bonds along with additional things like real estate or even put tangible assets like properties and businesses in your child’s name. A UTMA allows you to do everything that UGMA does, plus more. (UTMA’s are not offered in every state so some people are limited to a UGMA).
 
How does it work?
 
You call up a financial institution, like Fidelity, Vanguard, TD Ameritrade, etc, and let them know you want to open a custodial account for your child. The account will be in your child’s name and you will be the “custodian” or the person controlling the account. You then put as much money as you want into the account as often as you’d like to invest. Once your child hits the legal age of maturity (which ranges from age 18-21, depending on the state) they get all the money in the account. Some states like Florida, give you the option to delay the age in which your child gets the money until age 25, if you want.
 
What are the advantages?

1. It allows you to invest money for your child. By investing money, instead of merely saving it, you will be able to stack up more money for your child over time. If you saved $25 a month for your child starting from the time they were 5 years old, by the time he or she turned 21 you would have stacked $4,800. However, if you had instead invested that money (in index mutual funds which make an average of 10% per year) by the time your child turned 21, he or she would have $10,780. That is more than double what you would have if you only put the money in a savings account! 

2. It provides more flexibility than other investment accounts. Unlike other investment accounts that you can open for your child (like a 529 account or a Roth IRA), with custodial accounts there is no rule on what your child can or cannot spend the money on. If they decide to go to college, they can use it for college. If they want to open a business, they can use it for that. If they want to spend ½ of it to buy a home and the other ½ to pay for their wedding or fund a travel experience overseas they can do that too. It’s your child’s money to do as he or she wishes.

3. There is no contribution limit. With a custodial account there is no income limit on who can and cannot contribute to the account (like there is with an Educational Savings Account) and there also is no limit to how much or how little you can put into the account each year (like there is with a Roth IRA). It doesn’t matter if you are rich, poor, or somewhere in between, anyone can contribute any amount of money to a custodial account as frequently or infrequently as they want on behalf of their child. Contributions over $15,000 per year will trigger the federal gift tax, but technically speaking you can put as much money in the account as you want. That is not the case with some of the other investment accounts.

What are the drawbacks?

Like almost any type of account, there are things to be cautious of if you decide to open a custodial account on behalf of your child:

1. The money is your child’s to keep and you can’t take it back. If you are in a financial bind and need money for an unexpected car repair or to repay debt, you cannot withdraw money from the custodial account to do so. When you contribute money to the account you are legally giving the money to your child. This means you cannot take the money back later if you want to. It belongs to your child.

2. Your child can spend the money on whatever he/she wants. Once your child hits the legal age of maturity, it is their money to spend how they want. While this gives them lots of flexibility, it can be problematic without the right discipline. You may want your child to spend the money on college expenses or a home down payment but he or she may instead choose to spend the money on a fancy car, blow the money on drugs and clubs, or lose it all gambling. 

3. You have to report it on your tax forms and any financial aid forms for school. Since it’s an investment account that makes money, technically speaking, your child must pay taxes on the profit made from investing in the account. Any profits made in excess of $2100 per year is taxed at your (the parent’s) income tax rate. You can choose to pay taxes on your child’s behalf. You can also minimize any taxes owed by investing in low-cost index funds and simply waiting until your child reaches the legal age of maturity to sell any investments. However, if your child goes to college, he or she will have to report any assets they have (including money in this custodial account) to the school which may decrease how much financial aid he or she is eligible for. 

Given the drawbacks is it still useful?
 
Many people think so, but that’s a personal decision that you have to make for yourself. If you know your child will blow the money on drugs and parties then perhaps a custodial account isn’t the best place to invest the money. If you aren’t sure if your child will go to college or anticipate they may need money to pay for a wedding, buy a car, or start a business in the future, then perhaps a custodial account is a good place to invest money.

If you invest money in a custodial account then realize that your child wants to go to college (or think they may be irresponsible with the money in the custodial account) you can use the money to pay for college directly or transfer money from the custodial account into a 529 college account in their name. My point? Custodial accounts can be useful and you can invest in them in addition to other investment accounts like a 529 college savings account or a Roth IRA.
 
Tell me, would you consider opening a custodial account for your child? 

Plan for the Unexpected

If there’s one thing I’ve learned as an adult it’s that sometimes things just happen. You may think you are on track with your career, your finances, or your personal life, but life has a way of surprising us. Sometimes these unplanned events are good. We get a promotion at work, another stimulus check from the government, or an impromptu visit from a friend we haven’t seen in a long time. But other times, these surprises are major problems we couldn’t have predicted or avoided, especially when it comes to finances.

You may be costing along, saving and investing a certain percentage of money and then something unexpected happens. Your car breaks down, your laptop dies, or something urgent comes up that requires your time, attention, and money. Up until a few years ago, these unwelcome occurrences would get me down and make me anxious. I’m a planner who would get frazzled whenever things deviated from how I envisioned.

In order to decrease my anxiety, and feel better prepared, I needed to start planning for these inconveniences, at least the financial ones. I used to just rely on my emergency fund, but then I realized I was needing to dip into that fund a little too often, so I had to put a better plan in place.

My solution was 3-fold:

1. Cut back on unnecessary spending elsewhere. I re-examined my budget and tried to think about ways I could cut back. For me, it was decreasing the amount of money I spent each month on food and wine, especially when I’d travel out of town. I set a preliminary spending limit every time I went to a restaurant so that I wouldn’t go overboard. I also began to cook more at home and was more diligent about searching for discounts whenever I’d travel out of town.

2. Set extra money aside each month. For me it was $200. Whenever I got paid I’d automatically plan for $200 to be gone in “incidentals.” If I didn’t have to spend the money one month then I could use it however I pleased but if I did need to spend the money then at least doing so wouldn’t totally wreck my budget. Having money set aside for these unexpected expenses made me less stressed when things would come up.

3. Increased my income. While I was waiting to see if I’d get a raise at my main job, I took matters into my own hands. How? By trying to make more money from other income sources. Whether it was working extra shifts at the clinic or trying to monetize my hobbies and side hustles, I tried to increase my income so that unexpected expenses wouldn’t totally destroy my budget and savings goals each month.

Do you also have added expenses that come up each month that throw you off your game?

If so, the solution isn’t to just charge the expenses on a credit card and hope to pay off the card someday. You may want to adopt a plan similar to mine so that you are more proactive and less reactive when/if these unexpected expenses occur.

5 Changes to Enhance Your Life

1. Dedicate more time to your side businesses and passion projects. Take time to think about things you’d like to do or accomplish in your life. Perhaps you want to start a business, volunteer for an organization you love, or work on a passion project? Whatever it is, write it down and make a point to work on these goals periodically. One way to ensure that you are progressing is to brainstorm different times within certain days each week that you can dedicate to these goals. Make it a habit to work on the things you are passionate about on a regular basis.

2. Read more books, watch less tv. The most successful people have habits and character traits that are distinct from others. One of those traits is their intellectual curiosity and commitment to lifelong learning. One of the ways they do this is by reading books, listening to podcasts, and staying educated on a variety of topics. Unlike many typical Americans, most millionaires who were not born into wealth don’t spend as much time consuming entertainment. They don’t watch as much television as other people. Although they value relaxation, they are extremely selective about how they spend their days. Be mindful of how much time you spend consuming entertainment.

3. Spend less time on social media. Although social media can be a great way for us to check up on friends and give us a small glimpse into the lives of people we care out, there are downsides as well. One of the biggest drawbacks is that it can be quite addicting. Many people spend hours scrolling on social media each day without realizing it. Along with causing us to waste valuable time, social media can cause us to unnecessarily compare ourselves with others in ways that makes us less content with our own lives. In order to avoid feelings of discontentment and use your time more wisely consider cutting back on your social media use.

4. Get healthier – eat more nutritious food and exercise regularly. Many successful people value good health. They understand that sub-optimal health costs us extra money, since we have to pay for more frequent doctor’s visits and medicines to treat illnesses that could have been avoided. Bad health also costs us time. If you are healthier, you have more energy to get things done and can be more efficient with your time. You also tend to feel better in general. Consider eating healthier foods and exercising more regularly to improve your health and productivity.

5. Allocate more money to saving and investing. Part of being successful means practicing good money management. Instead of spending lots of money on frivolous things many successful people live below their means and allocate at least 20% of their money to saving and investing. You should consider doing the same thing. Make it a habit to save at least 5% of your income to build up an emergency fund. Consider allocating at least 10% of your income to retirement investing. You can use any remaining money to invest in taxable accounts, open college savings accounts for your children, or save money in a vacation fund for an upcoming trip. If you don’t do this already, make it a habit to save and invest a certain percentage of your income.

5 Habits That Can Make You a Millionaire

1. Setting up automatic investments. The vast majority of young millionaires achieved their financial status by investing money. Unless they are a celebrity or were born into a wealthy family, they had to be diligent about investing money either in the stock market, a business venture, or real estate. You must do the same. One way to do this is by making your investments automatic. Have a certain amount of money (aim for 10-20% of your salary) automatically deposited into your work retirement account, Roth IRA, or brokerage account. Invest the money inside of the accounts in index mutual funds, which make a profit of around 10% each year. Making these investments automatically prevents you from having to put money in the account each month. When you don’t rely on yourself to make the investment and instead make it automatic you increase the chance that you will meet your investment goals and accumulate wealth faster.
 
2. Having a separate account for savings. Along with investing 10-20% of their income, many young millionaires also have a certain amount of money they save. While most people start off with a goal of having $1,000 in a savings account for emergencies, many young millionaires and financially savvy folks exceed this amount. The general rule of thumb is to have 3-6 months of living expenses in a savings account just in case your income changes or you happen to lose your job. Aside from having money in a savings account, many financially savvy young professionals also save money for other things like yearly vacations, home purchases/renovations, holiday gifts, or car repairs. Consider setting up savings accounts for those things as well.
 
3. Living a modest lifestyle. Aside from saving and investing money, many financially savvy folks who achieve millionaire status also live a modest lifestyle. Instead of spending money on numerous expensive things, they tend to live below their means. In fact, there’s a saying that you can either look rich or be rich, but most people can’t do both. In order to ensure that you have enough money to save or invest 20% of your income you have to decrease the amount of money you are spending on other things. This means, you will probably not be able to lease expensive cars or buy a large home. Becoming a millionaire requires that you prioritize building wealth by investing a large chunk of your income. For most people, living a modest lifestyle is the sacrifice they make to invest the amount of money needed to build wealth.
 
4. Pre-planning large expenses/vacations. Most people don’t just wake up rich. Becoming financially successful at a young age requires a great deal of planning. Instead of being surprised by unexpected expenses or accumulating lots of credit card debt after each vacation many financially savvy folks plan ahead. They save in advance for large purchases and vacations. They create a budget for how much they will and won’t spend. Then they stick to it. A large factor in who does and does not accumulate wealth, depends on how disciplined you are and how well you plan ahead. Start doing so now.
 
5. Paying down [personal] debt aggressively. Lastly many financially savvy folks who end up becoming millionaires for the first time at a young age try to minimize personal debt. They try to avoid taking out huge car loans or mortgages and tend to pay back any money charged on the credit card within a short time frame. They understand that accumulating debt and keeping it for long periods of time costs them more money in the long run since they end up paying a great deal in interest. Most financially savvy people seek to make interest by investing money instead of paying interest by accumulating debt.
 
Tell me, do you want to be a millionaire at a young age? If so, what are some things you can start doing to put yourself in a good position to reach that goal?