Tuesday, August 27, 2013

Financial Gifts for Kids

Do you ever feel like when you stuff that $5 into a birthday card for your niece or nephew every year that you're actually doing them more harm than good? After all, they'll probably just end up buying candy or some cheap-o toy with it that will do nothing more than end up broken, lost, or forgotten, right? Maybe you've thought about more permanent financial gifts, like savings bonds or other such investments, but beyond that, aren't really sure what's a good investment for a kid. Fortunately, there are a host of options that you can look into, each with its own benefits and, of course, drawbacks. 

Savings accounts these days usually offer pathetic fractional interest rates, and some even charge fees for accounts that aren't used regularly, which eats into the savings put there unless you're willing to pony up tens of thousands of dollars! Even then, you might find that the account is nickeled and dimed to death before the kid even has a chance to decide what college they want to go to. Sure, a savings account is a “safe” option, but for long-term investment, such as is important for a toddler hoping one day to attend Harvard or Cornell, that sort of account will actually lose you money, and we’re not talking about bank fees here, either, but that dreaded nemesis of savers everywhere, inflation. For a short course in inflation, the US Inflation Calculator is a fun and interesting way to break your own heart, but for our purposes, if we bought something for $20 in 1993, that same item would cost us $32.33 today, which correlates to a 61.7% cumulative rate of inflation. To compare, let’s use a fairly typical interest rate that many banks are offering today, .9%. That’s point-nine-percent, not nine percent! If we put aside $20, then let it build interest without being touched, it would only reach a total savings of about $26.50. Pretty yucky, right?

IRAs are one way to give a child a financial gift that will easily surpass the rate of inflation, but investing in them for a child can be tricky. You have to choose whether to make the account a custodial or guardian account, whether it will invest in stocks, bonds, or other stuff, and, of course, what kind of account it will be. Check out these three points you’ll have to consider when you decide to set up your accounts.

Custodial or Guardian?

This option essentially names “ownership” of the account funds. Under a custodial account, for example, the funds are controlled by you until the child reaches maturity, at which point they assume control of the account and can pretty much spend it as they see fit. This is a good idea for kids who you know are responsible and know the value of a solid investment. On the other hand, guardian accounts ensure that you retain full control over the funds in the account. You can do with them what you please, including taking those funds away should the kid end up displaying a pretty gross lack of responsibility right up through college. 


The three IRA accounts that are available, Education, Roth and Traditional, get into some more complicated financial matters - you can’t have an IRA unless you have earned income, so unless your kid is making money somehow, an IRA can’t be opened in their name. Opened in your name, there are tax questions to consider, so consult an accountant before you get too far along in the process.

Stocks, Bonds, and Other Stuff

You can pretty much put whatever you want into an IRA account, so if that option is available to you, know that you can then begin to spread out the investment over a number of different options. Stocks, obviously, are the most volatile, but may also provide an enormous return when compared to other funding options. Bonds are good choices but seldom perform too much higher than inflation. A good intermediate step you might consider is mutual funds.

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