By Stephen W. Bedikian, Associate Wealth Advisor
Congratulations! Is it a boy or a girl?
Most expecting parents are focused on preparations like acquiring all the items they will need before their child’s birth – and then they’re consumed by the daily activities involved in taking care of their newborn.
Starting early is a key component of investing for your child’s future
It may seem premature to be thinking about your child’s financial future during this time. But it’s not. That’s because in investing for the future, the power of long-term compounding depends on time. It can make a big difference if you start investing at your child’s birth, rather than waiting a decade and starting after you read that article about the exorbitant cost of college tuition.
Compounding is simple: you get paid interest on the interest you previously earned, not just on the principal amount you originally invested. To illustrate, if you start out by investing $10,000 and earn a 10% return in the first year of your child’s life, that’s already a $1,000 gain, which in turn can be reinvested to yield greater returns over time. So, in year 2, you’re earning interest on $11,000 (not just the original $10,000). If, many years later, the account value has grown to $100,000, that same 10% annual return equals $10,000 (ten thousand dollars).
Thus, the power of compounding is said to be back-loaded, meaning the larger potential benefits are toward the end of the investment period.
Can I open an investment account for my child?
Yes. There are a number of investment options to consider, depending on your objectives.
- UTMA/UGMA Accounts. These are custodial accounts created under a state’s law (either the Uniform Gifts to Minors Act or Uniform Transfer to Minors Act) to hold gifts or transfers that a minor has received. The assets are owned by the minor and are reported under their Social Security number. Investment earnings are taxed annually as the minor’s income.
- A custodian (a parent, for example) manages the funds until the minor reaches adulthood. At that time, they gain full control of the assets, which can be used for any purpose. Contributions to a UTMA/UGMA are not tax-deductible and earnings are not tax-deferred.
- 529 Account. Want to invest for your child’s education? A 529 account is a state-sponsored savings plan for educational expenses that allows for tax-deferred growth and accumulation of earnings. Contributions are not tax-deductible. If the funds are used for specific educational purposes, they are not subject to state or federal income taxes when withdrawn. Some states offer tax deductions or credits for contributions to their 529 plans.
- Contributions can be made by parents, relatives – or anyone else. The account owner makes investment decisions, and the child is the beneficiary. Originally the funds could only be used for specific college-related expenses but the Tax Cut and Jobs Act of 2017 allowed for use of funds for K-12 private school expenses up to $10,000 annually.
- Trump Account. The recently passed One Big Beautiful Bill tax law created so-called ‘Trump Accounts’ for children. The federal government will seed the account with $1,000 for children born between January 1, 2025, and December 31, 2028. Employers can contribute up to $2,500 annually and parents, relatives and other entities can contribute another $5,000 annually in after-tax dollars. No distributions are allowed until the child turns age 18; thereafter, it’s treated like an IRA. The IRS is developing detailed guidelines, and it is expected that accounts can be opened after July 2026.
- Whole Life Insurance Policy. Parents who are thinking longer term can consider a whole life insurance policy for their child. A whole life policy consists of an insurance component and a tax-deferred savings component. The insurance expense will generally never be cheaper than when a policy is purchased at birth. A mutual life insurance company will pay dividends to policyholders that can accumulate on a tax-deferred basis. The funds inside the policy savings account can compound tax-deferred for the duration of your child’s life – which could be eight or nine decades, or even more, considering how longevity is trending.
There are two additional strong rationales behind taking out these policies early in your child’s life. Most people don’t start contributing significantly to a 401k plan or IRA until they are 25-30 years old. That means those funds are likely to compound for, at most, four to five decades before they are subject to required minimum distributions (RMDs). There is another benefit that parents may be reluctant to consider: Some children develop health conditions during their lifetime that will make them uninsurable. If they have a policy already in place, that potential risk can be addressed at birth.
What’s the best investment plan for my child’s future?
The best investment plan for your child’s future begins by taking into account your values and aspirations for them. We’re here to help you determine the investment options that are appropriate for your growing family, and would love to have that conversation with you. And keep in mind that holidays and birthdays are a great time to ask grandparents and other relatives to consider making a contribution to your child’s account and their financial future.
Give your child a strong financial start by investing early
So, congratulations to the new and expecting parents. While you’re busy preparing for your baby’s arrival and caring for their first milestones, remember that even small financial steps today can create lasting opportunities for their future. At Halbert Hargrove, we’re here to guide you through the options and help you design an investment plan that reflects your family’s goals.
Disclosure:
Halbert Hargrove Global Advisors, LLC (“HH”) is an SEC registered investment adviser with its principal place of business in Long Beach, California. HH may only transact business in those states in which it is registered, notice filed, or qualifies for an exemption or exclusion from registration or notice filing requirements. Registration does not imply a certain level of skill or training. For information pertaining to the registration status of HH, please contact HH or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov). Additional information about HH, including our registration status, fees, and services can be found at www.halberthargrove.com.
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