Investing to Benefit Minors in Your Life

By Holly Franklin

If you’re like most people, the minute you find out you’re going to be a parent (or a grandparent), you will begin to think about the life of that child. What will they look like? What personality will they have? Will they be smart? Will they go to college? Once we begin to think about college, it’s usually down the rabbit hole from there. How much will it cost in 18 years? How can I save enough while also saving for myself? Can I invest money while saving for college? While we can’t see the future to tell you exactly what college will cost two decades from now, we can give you some information on different types of savings/investment accounts for your children so you’re prepared. 

The first option is what’s called a 529 plan. A 529 plan is a college savings plan that offers tax and financial aid benefits to you and your child/dependent. Generally, this type of account will have an owner (typically the parent or grandparent) and a beneficiary (the dependent). Contributions to this plan are like contributing to a Roth IRA in that they are made with after tax dollars. In other words, after Uncle Sam takes his cut of your paycheck, you may then designate some of the money left over to go into your 529 plan. This ensures that when your child goes to take money out of the account for school, they won’t have to pay taxes on it. On financial aid forms, the 529 plan is reported as a parent asset and the distributions are not counted. This makes for a more favorable financial aid treatment for the student because student assets reduce need-base eligibility by 20% of the value of the asset, while parent assets reduce eligibility by around 6%. Conversely, if the 529 plan is held by a non-custodial parent or a grandparent, there is no financial aid eligibility implication, provided the person does not financially support the student in any way. If the non-custodial parent or grandparent do provide financial support, the account will be reported as student income. There is no age limit to starting or withdrawing from a 529 plan; however, the funds must be used directly for school to avoid penalty. There are other stipulations depending on which state you’ll be opening your account in which you can discuss with your financial advisor. 

If a 529 plan sounds too stringent, you may want a Uniform Transfers to Minors Act (UTMA) Account. In this account, an adult will act as the custodian holding assets for a minor child (it needn’t be a parent or even a relative). The adult can then manage the assets, make investments, buy and sell securities, and transfer assets across different UTMA accounts. The money is taxed at the beneficiary’s tax rate. Even though the custodian has overall control of the UTMA, there are some restrictions on what the money can be spent on. For instance, a parent cannot spend the money to support the child (ie. Food, shelter, and other legally required expenses). A parent can, however, spend the UTMA money on a vehicle for the child, tuition costs or similar things on the child’s behalf. Once the child becomes a legal adult, they become the custodian, and at that point, there are no restrictions on how the money is spent in the account. This may be a disadvantage to those who want control over the assets past the beneficiary’s adulthood. Another possible disadvantage is that these funds are considered assets of the beneficiary, so when applying for financial aid, eligibility is reduced at the 20% student rate as opposed to the 6% parent rate. On the other hand, if you want your child to be able to spend their money as they see fit, the flexibility of this plan may be more attractive to you than the more restrictive 529 plan.

The third and less common type of plan is called a Coverdell Education Savings Account. A Coverdell account behaves much like a 529 plan in that the contributions are after tax with tax free withdrawals. Where the Coverdell account differs from a 529 plan is that the Coverdell has more flexibility in what the money can be spent on. In a 529 plan, tuition for K-12 is limited to $10,000; in a Coverdell account, the funds can be used for books, supplies, equipment, tutoring, etc. and there is no limit on K-12 tuition. Some restrictions the Coverdell accounts do have are: they’re only available to families below a modified adjusted gross income of $220,000, you cannot contribute to the account past the child’s 18th birthday, and you cannot change the beneficiary if the child chooses not to go to go to a qualifying school.

For many people, the decision on which account to invest for the child in your life will come down to a few main factors. Do you want control over how the money is spent? Do you want to keep custody of the account past the minor’s age of maturity? How much flexibility will you need when considering what to spend the funds on? All three of these plans come with investment opportunities and various tax benefits depending on your situation. Every family has their own unique needs and could benefit from seeking the help of their financial professional to weigh the pros and cons of each type of account. 

IMPORTANT DISCLOSURE INFORMATION

Please remember that past performance may not be indicative of future results.  Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Paragon Wealth Strategies, LLC [“Paragon”]), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.  Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions.  Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from Paragon.  Please remember that if you are a Paragon client, it remains your responsibility to advise Paragon, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Paragon is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of the Paragon’s current written disclosure Brochure discussing our advisory services and fees is available for review upon request or at www.wealthguards.com. Please Note: Paragon does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to Paragon’s web site or blog or incorporated herein, and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please Also Note: IF you are a Paragon client, Please advise us if you have not been receiving account statements (at least quarterly) from the account custodian.