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What You Need to Know
A 529 plan is still the strongest choice if your main goal is saving for your child’s education.
A Trump account can help jump-start retirement savings, especially if your child qualifies for the $1,000 seed money.
A Roth IRA may be a better fit once your child has earned income, thanks to tax perks and more investment flexibility.
Want to set your child up for financial success but aren’t sure where to start? With so many options, from IRAs to the new Trump accounts, the choice can be daunting.
To help readers understand the different accounts, Investopedia connected with Jonathan Lee, a U.S. Bank Wealth Management Advisor, who broke down which accounts to open for kids and why.
What This Means For You
Helping your child build wealth starts with knowing what you’re saving for—college, retirement, or a future big expense. Once the goal is clear, it’s easier to choose the account with the right mix of tax perks, flexibility, and rules.
➤ What types of accounts should parents prioritize contributing to if they want to invest for their child’s education? Or a future down payment on a home? What about for their child’s retirement?
Jonathan Lee: For education planning, a 529 savings plan is going to be worthwhile for tax-deferred growth as well as tax-free distributions for qualified education expenses.
For retirement savings, a Trump account can be useful for children born between 2025 and 2028. The federal government can and will contribute $1,000, but only if the parents—or whoever is setting up the account—makes the election to get that $1,000. ... I will always encourage people to do the thing that seems too good to be true and take the free money.
The Trump accounts are also great in that employers can contribute. Potentially, an employer can contribute $2,500, and that does go against the $5,000 annual, adjusted-for-inflation limit.
Go for it [if your employer can make a contribution or you receive the $1,000 initial contribution], but understand the limitations surrounding [investment] diversification.
If you want to, say, help your child save for a down payment, Trump accounts would not be a good vehicle because there could be penalties for withdrawing from the Trump account before age 59½, and I’d imagine that your child is going to want to buy a home before that time.
A brokerage account would be an OK route to go. Some of that 529 plan can also be converted into a Roth IRA. And there are some rules about using [Roth IRA] funds as a first-time homebuyer, too.
➤ Can you talk more about the differences between 529 savings plans and Trump accounts?
Lee: A 529 plan is designated for education expenses whereas a Trump account is really designated to be a retirement savings vehicle from childhood or birth. For that 529 plan, withdrawals are tax-free for qualified expenses.
The Trump account is not to be used as a substitute for a 529 plan, but can be complementary to achieving objectives for the child.
➤ And for parents who are interested in helping their child save for retirement, would a Roth IRA also be a good choice if a child has some income from, say, a summer job?
Lee: A Roth IRA is a good vehicle because a child is in a low tax bracket. With a Roth IRA, you are contributing after-tax dollars, so a child is not really being taxed that much.
Beyond that, you also have tax-free growth and [you can withdraw] Roth IRA contributions [whenever]. It’s only the earnings that need to be taken out after age 59½. You can also diversify globally with a Roth IRA, which you’re not able to do with the Trump accounts.
You can still keep costs low. This is also a big emphasis in the Trump account initiative—expense ratios [on funds available in Trump accounts] are limited to 0.10%.
[With a Roth IRA], you can not only invest in ETFs from the U.S., but from [other] developed and emerging markets, too. You can also invest in bonds, commodities, and real estate investment trusts.
For parents who want to help their children save for retirement, consider that Roth IRA option when they start earning money. It also gets that child into the habit of saving for retirement.
It’s one thing when a parent does it with their own money on behalf of a child. It is another thing when you’re able to instill discipline at an early age.
Read the original article on Investopedia
