Saving for a 5 year old

  • Dear Dollar Stretcher,

    I have a five year old child and she was given $10,000 from her grandmother. In August 2015 I opened a 529 account that I contribute $50 biweekly and I use my Upromise rewards to be deposited into this account. The Upromise is quickly adding up and I pay my credit card balance off monthly.


    My accountant suggested opening an online TDAmeritrade account and find investments. I am somewhat conservative and afraid of market. I would pick stable stock that are established.


    My question is am I better off just putting the $10,000 into the 529 (money is invested in moderate funds). or do my own investment portfolio as a custodian for my child?

    Thanks,

    Ann

     

    Ann,

    Good question. Actually 2 questions. 

     

    The first one relates to how the gift should be titled. As a minor the gift needs to be put into an account for your daughter's benefit, but with control in the hands of an adult (at least until your daughter becomes an adult). A common type of account is a UGMA (Uniform Gifts to Minors Account) that would have you or another adult as custodian for your daughter. You control it when she's a child, she controls it when she reaches adult age.

     

    A UGMA account can include most any type of investment. Anything from a simple savings account at a bank up to a brokerage account where you chose stocks, bonds or mutual funds. Any income would be taxable to your daughter. But if this is her only income she shouldn't owe any federal income taxes.

     

    The 529 account would be another alternative. It's a savings account for your child's college education. Here's how the SEC explains it: "A 529 plan is a tax-advantaged savings plan designed to encourage saving for future college costs. 529 plans, legally known as “qualified tuition plans,” are sponsored by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code." Any earnings generated will be federal (and possibly state) income-tax-free as long as withdrawals are used for qualified higher education expenses. 

     

    There is a downside. If you withdraw money from a 529 plan and do not use it on an eligible college expense, you generally will be subject to income tax and an additional 10% federal tax penalty on earnings. So any money put into a 529 plan really needs to be used for college.

     

    Depending on the firm that hosts the 529 account for you (like a brokerage, mutual fund or a bank) you'll have a variety of investment options. 

     

    You'll need to decide whether you want to put that gift into the 529. You probably can achieve the same tax situation without tying yourself to college in a UGMA account.

     

    The other question is where to invest it. You want to balance safety with earning potential. Try to achieve a balance. Not too much safety nor too much risk. Picking individual stocks would give you the greatest potential, but also brings the greatest risk. I'd be more prone to suggest choosing an index fund that would track the broad market. 

     

    A reasonable return would see that money double by the time your daughter reaches college. It's a fine gift that she's been given. And your efforts to invest it wisely are what a wise parent does!

    Keep on Stretching those Dollars!

    Gary


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