5 Ways to Maximize Benefits for Your New Family Member’s Future
Children bring happiness but also a lot of responsibility. What do you need to know as financially responsible parents who are excited about beginning to set up a savings and investment strategy for your new family members? What kind of accounts can you open for them in terms of investments? How are the profits from your new family members’ investments taxed? How can you make the most of your child’s tax benefits wisely?
This post will discuss the different types of family-friendly investing accounts and present financial planning “hacks” to make tax-smart selections.
529 College Savings Plan
A 529 plan is a great investment vehicle created especially to cover school expenses. A 529 plan allows for tax-free growth of contributions and tax-free withdrawals for eligible expenses related to education. Use this account to fund your child’s future education and look into possible state tax breaks and matching programs to get the most out of your savings. Even before your new child arrives, you can open this account and begin saving and investing; simply designate yourself as the beneficiary until they receive their Social Security number, at which point you can transfer the beneficiary to them.
Custodial Accounts (UTMA/UGMA)
With a UTMA or UGMA account, you may invest money for your child. There will be no more changes to the account once the person turns 18. This type of account, in contrast to the 529 plans, can help you pay for your child’s other needs besides school, like a down payment on their first home later.
Although the income from these accounts may be subject to unearned income tax at the child’s tax rate, take note of the “kiddie tax,” which collects taxes on unearned income earned by children under the age of 18, or 24 if they are full-time students, if it exceeds a specific level ($2,300 in 2023). Over this amount, unearned income is subject to taxation at the parent or guardian’s tax rate.
If this account is used wisely, there are ways to hack taxes for everybody in the family. Use investments that provide eligible dividends or long-term capital gains and less investments that create interest income to manage your portfolio to reduce your taxable income strategically. Alternatively, think about transferring high-gain assets to your child’s UTMA account, then selling them and realizing the capital gains to allow the gain to be taxed at the child’s lower tax rate instead of your usual higher tax rate.
Coverdell Education Savings Account (ESA)
An additional tax-favored account for educational savings is the Coverdell ESA. While the gains grow tax-free and withdrawals for eligible educational costs are tax-free, the contributions are not deductible from taxes. With a $2,000 annual contribution cap for each child, this account might be an advantageous addition to your total education savings plan.
Roth IRA for Children
Should your child have received income, you might want to open one for them. Although growth and eligible withdrawals from a Roth IRA during retirement are tax-free, contributions to the account are made with money earned after taxes. Encouraging your child to open a Roth IRA early on can provide them access to a valuable instrument for building long-term wealth.
For instance, if you own a small business and you pay your child to model for the marketing campaign of your website, the money your child gets paid for the work they do is their earned income. Hiring this young model will cost you a little money in the interim. The IRS-set annual contribution cap, which is subject to annual adjustments, or the lesser of earned income is the maximum annual contribution limit for a Roth IRA. For instance, your child may make up to $2,000 in Roth IRA contributions throughout the tax year if their income from employment is $2,000 or more.
Investments to a Roth IRA are not age-limited, but your child must be earning money via self-employment or a valid job. Your child’s compensation must be fair and similar with what you would pay someone else to perform the same employment. To support the salaries given, it’s critical to keep accurate employment records and to document the assignments that were completed. Even if your child may have received income, you still need to think about the tax impacts. Your child might have to file a tax return if their income rises above a particular level. But they may not owe any federal income tax if their income is less than the standard deduction amount, which varies annually.
Plan for the Best Tax Savings by Utilizing Child-Related Tax Credits
Your family may benefit financially from child tax credits, which can help with the expenses of raising children. Parents may improve their financial condition by employing various financial planning methods and tax benefits related to raising children.
This benefit lowers taxes for each eligible child under the age of 17. The credit value and qualifying requirements are state-specific and subject to change annually. It’s vital to check the precise guidelines on the IRS website or speak with a tax expert to find out if you qualify.
Child and Dependent Care Credit
With this credit, parents can deduct a percentage of their daycare costs from their taxes. A portion of eligible daycare costs serve as the basis for the credit, subject to certain limits. If you qualify for this benefit, carefully plan when to pay for childcare. To optimize the credit, for instance, you would wish to focus these costs during a year when your income is higher if you have the option of deciding when to incur them.
Higher education costs can be made up in part by the Lifetime Learning Credit and the American Opportunity Tax Credit. Look into the various education tax credits that are available if your child is going to college and select the one that will help them the most. To get the best possible tax advantage for your situation, compare the lifetime learning credit, the American Opportunity Tax Credit, and any other education-related tax credit.
We assist our clients in examining their tax returns and are financial consultants, but we are not tax experts. Please get additional advice from a tax expert who can guide you through the details of child tax credits as taxes can be complicated. They can make sure you’re making the best choices possible by providing you with specialized recommendations based on your unique circumstances. Keep in mind that following tax rules and regulations is essential.
Disclosures:
This information is presented for educational purposes only and should not be treated as tax advice. You should seek tax advice from your professional advisors before implementing any transactions and/or strategies regarding your finances.
Thao Truong
Thao Truong joined Morton Wealth in December 2020. She has over 12 years of experience in the wealth management business. Before joining Morton Wealth, she held various roles in financial planning, private investments, portfolio design, and advisory services at other independent advisory firms based in San Francisco and San Diego. Additionally, Thao is a CERTIFIED FINANCIAL PLANNER™ professional. She graduated magna cum laude with a B.S. in finance and economics from the University of New Hampshire. Born and raised in Saigon, Vietnam, she moved to the United States by herself and became financially independent at age 16. Thao is dedicated to supporting youth and women through life transitions and closing the financial literacy gap. She recently helped launch “Herself by Morton,” an initiative that provides women free networking opportunities and financial education resources. She is one of the honorees of the 2022 class of 40 Under 40 by InvestmentNews and is named on the Financial Advisor Magazine‘s 2023 prestige list of YoungAdvisors to Watch.