Lesson 3: Investment Choices for Your Child’s Future

Saving for Beneficiaries

A beneficiary is an individual or entity designated to receive the assets of a financial account, investment, or insurance policy. This ensures that assets are distributed according to the account holder’s wishes and provides clarity on decision-making regarding fund usage. Beneficiaries play a critical role in financial planning, especially when it comes to securing your family’s future. When an adult opens an account on behalf of a minor, understanding the concept of beneficiaries becomes paramount.

There are three primary types of beneficiaries:

1. Primary Beneficiary: This is the first person or entity entitled to receive the assets upon designation, either upon the account holder’s death or when a child reaches adulthood.

2. Revocable Beneficiary: With this designation, the account holder can change or revoke the beneficiary designation at any time without the beneficiary’s consent. This flexibility allows for adjustments as circumstances change, such as adding additional beneficiaries.

3. Irrevocable Beneficiary: Once named, an irrevocable beneficiary cannot be changed or revoked without the beneficiary’s approval. This designation provides a level of permanence and security for the beneficiary.

Designating beneficiaries is essential for ensuring that assets are distributed as intended and securing your family’s financial future. It also clarifies who has control over the assets, including managing investment decisions, withdrawals, and tax implications. Additionally, beneficiary designations can impact net worth calculations for loans or financial aid applications. Understanding and properly designating beneficiaries are critical steps in effective financial planning.

Investment Options

If you seek to maintain control over investments while saving for your child’s future, several top choices are available:

1. IRA (Individual Retirement Account): While typically associated with retirement savings, IRAs can also serve as a versatile tool for other financial goals, including saving for a child’s education or purchasing a first home. With a Roth IRA, contributions are made with after-tax dollars, and qualified withdrawals, including those for educational expenses, are tax-free. However, it’s important to consider income and contribution limits when utilizing a Roth IRA for education savings.

2. General Brokerage Account: A general brokerage account provides a flexible investment option for saving for your child’s future. Unlike retirement accounts, there are no restrictions on how funds can be used, making it suitable for various financial goals, including education savings. With a brokerage account, you have the freedom to invest in a wide range of assets, such as stocks, bonds, mutual funds, and ETFs. Additionally, there are no contribution limits or withdrawal penalties associated with brokerage accounts, offering greater flexibility in managing your child’s financial future.

If you prefer to maintain control over investments while specifically saving for your child’s education, you might consider an education savings account:

1. 529 College Savings Plans: Among the most popular choices for funding your child’s education, 529 college savings plans are sponsored by states and provide tax benefits along with flexible investment options. Contributions to a 529 plan grow tax-deferred and can be withdrawn tax-free for qualified education expenses.

2. Coverdell Education Savings Account (ESA): Another tax-advantaged avenue for educational savings, Coverdell ESAs offer opportunities for tax-deferred growth and tax-free withdrawals when utilized for qualified education expenses, encompassing both K-12 and college expenditures. However, it’s essential to be mindful of contribution limits and income restrictions associated with Coverdell ESAs.

If you aim for the beneficiary to assume control over investments upon gaining access to the account, several top choices are available:

1. Custodial Accounts (UGMA/UTMA): These accounts, such as Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA) accounts, enable parents to invest on behalf of their child. Offering flexibility in investment choices, they can be utilized for various purposes beyond education. However, once the child attains the age of majority (typically 18 or 21, varying by state), they assume control of the account.

2. Child Brokerage Account: Also known as a custodial brokerage account, this investment account type allows parents or guardians to invest on behalf of a minor. Similar to custodial accounts, the adult oversees the investments until the child reaches the age of majority. Child brokerage accounts typically provide a variety of investment options, including stocks, bonds, mutual funds, and ETFs, facilitating parents’ ability to save and invest for their child’s future financial needs.

3. Whole Life Insurance: Whole life insurance can also be considered as a strategy for saving for a child’s future. Whole life insurance policies accumulate cash value over time, which can serve as a source of funds for various purposes, such as education expenses or a down payment on a home. Additionally, whole life insurance offers tax advantages and guarantees, providing a secure foundation for long-term financial planning.