When investing for a child's benefit, your choice of where to put the money will depend on your goals and timeline.
Whether you put the money in a high-yield savings, a brokerage or 529 account depends on when you might need the money and how it will best benefit your child.
While it's natural to want to put your baby first, don't forget to take care of your own financial future.
We just had our first baby and relatives have given us $1,000 in cash and checks for him. What's the best way to invest it? We thought about a 529 but aren't financially able to make monthly contributions right now. What are some other options?
Congratulations all around—to you on the birth of your first child and to him because he has parents who are already thinking about his financial future. There are several possible options for investing this money, and no matter what you choose to do, $1,000 is a good start. And the sooner you get it growing, the better. Interestingly, my last column was on the power of compound interest. You might check that out for even more affirmation on your decision to get this money working.
When it comes to deciding where to put the money, if a giver has indicated a preference, I'd start by honoring that wish. And even if they haven't, you might check in with your relatives just to make sure they don't have specific expectations for their gift.
If how you use the money for your child is totally up to you, look at it as you would any investing decision and begin by thinking about goals and timelines. As I'm sure you're well aware, expenses for your child begin on day one and continue for many years. So here are some questions to help you decide how this money can best be used, whether now or in the future.
Will you need the money short-term?
From daily expenses like diapers and clothes to big-ticket items like furniture and childcare to additional medical costs, a new baby can strain your budget. So first be realistic about how you'll cover short-term expenses. If you think the $1,000 will be needed in the near future, I suggest a low-cost, high-yield savings account that's easily accessible. Right now interest rates on online savings accounts are climbing (some as high as 2.25 percent as of this writing), so you might start there.
As a general rule, it's best to keep money that you might need in the next two to five years out of the stock market. Even though rates of return are potentially higher for stocks than for savings accounts, with a short timeline, you don't want to risk losing money you could need fairly soon.
Do you want to plan ahead for medium-term costs like summer camp, lessons or trips?
While these types of costs may seem far in the future, any parent will tell you how quickly they creep up on you! So if you think you're covered short-term, you might well think of this initial $1,000 as a "down payment" on the extras that you otherwise wouldn’t be able to afford. Again, a high-yield savings account is one option, as would be a CD that will mature at the time you expect to use the funds. However, if you have a longer timeline, you could also consider a custodial brokerage account.
With a brokerage account, you could invest in a broad-based stock mutual fund or ETF. That would give you the potential for more growth with the flexibility to access the funds when you need them. And by reinvesting the dividends, your investments can continue to grow. Of course, you always have to keep in mind that the risk with the stock market is that your investment might decline in value due to changing market conditions.
Also, in any custodial account, the money must be used for the benefit of the child apart from normal, everyday expenses, so it can be a good choice to handle those extras. But one caveat is that money in a custodial account becomes the property of the child at the age of majority (the age a person legally becomes an adult, which varies by state but is usually 18). That's a long way off but still important to consider.
Is saving for college a top priority?
With the eye-popping projected costs of college in 18 years (anywhere from over $100,000 for a 4-year public university to close to $300,000 for a private university), every new parent should consider saving for education as soon as possible.
You mention a 529 plan, and I believe that's one of the best choices if you want to earmark that $1,000 for long-term education savings. The tax advantages can increase significantly the longer you invest and an account is easy to set up. Minimum initial investments can be as low as $25. Also keep in mind that you're not limited to your own state plan.
Also, many 529s have low minimums for additional contributions (even as low as $1!), so you don't have to worry about monthly contributions. You can fit contributions into your budget according to what works for you, starting small and increasing the amount as you can. To get an idea of your 529 choices, check out sites like savingforcollege.com and collegesavings.org.
Another plus is that a 529 plan is an easy way for grandparents or others to contribute to your child's education, with special gift tax exclusions for large, lump sum contributions. And, with the new tax law, you can withdraw up to $10,000 from a 529 tax-free for private elementary and high school tuition as long as the plan allows it.
Some other practical considerations
As you consider the financial ins and outs of raising your new baby, here are a few more practical reminders to keep in mind:
- If you didn't request a Social Security number when getting your child's birth certificate, do so right away. It's necessary for opening accounts in your child's name and getting insurance.
- Make sure your child is covered on your insurance policy from birth.
- Create a will designating a guardian for your child should something happen to you. If you don't, the state will.
- Check on possible employee benefits or changes that you need to make with your benefits enrollment to help with health and childcare costs.
One more important thing: In the midst of all your new financial responsibilities, don't ignore your retirement fund. As counterintuitive as it may seem, your own financial future should still be a top priority. It won't jeopardize your kids' well-being now. And knowing that you're financially secure may actually give them greater peace of mind when they're grown up and on their own.
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