December 15, 2022

Investing in a Child’s Financial Future

One of the biggest goals of most parents is that their children become financially secure adults. To pave the way, it’s important to show young people the value of saving and provide them with the best education possible. By taking advantage of investment opportunities for you and your children, you can do both.


One of the best ways to get children on the right financial track is to set up IRAs for them. Their retirement may seem too far off to warrant saving now, but IRAs can be perfect for teenagers precisely because they have so much time to let their accounts grow tax-deferred or tax-free.

The 2022 annual contribution limit is the lesser of $6,000 (same as for 2021) or 100% of earned income. A teen’s traditional IRA contributions typically are deductible, but distributions will be taxed. Roth IRA contributions aren’t deductible, but qualified distributions will be tax-free. 

If your children or grandchildren don’t want to invest their hard-earned money, consider giving them up to the amount they’re eligible to contribute—but keep the gift tax in mind.


The UTMA allows minors to receive gifts they won't have access to until they become of legal age in the state in which they live—typically 18 or 21 years of age. The UTMA extends the original definition of gifts beyond cash and securities to include real estate, paintings, royalties, and patents.

Establishing an UTMA account provides a convenient way to save and invest without the parent carrying the tax burden. The IRS allows for an exclusion from the gift tax of up to $16,000 per person for 2022 ($17,000 for 2023) for a qualifying gift, including gifts to minors. The minor’s Social Security number (SSN) is used for tax reporting purposes on UTMA accounts. Because assets held in a UTMA account are owned by the minor, one of the drawbacks of using an UTMA account is that it can make the recipient less eligible for need-based college scholarship programs and other such initiatives.

The UTMA allows the donor to name a custodian, who has the fiduciary duty to manage and invest the property on behalf of the minor until that minor becomes of legal age. The property belongs to the minor from the time the property is gifted. If the donor dies while serving as custodian, the value of the custodianship property is included in the donor’s estate.


A Gift Trust is a separate legal entity that is designed to receive and hold gifts of property. Commonly used by parents or grandparents who want to establish a trust fund for their children or grandchildren, gift trusts are an estate planning strategy used to pass assets or wealth from the grantor—the owner of the assets creating the trust—to a beneficiary who receives the wealth. 

Gifts are made to obtain benefits not available if the property is given outright to a person. The gift tax is only triggered if the value of the asset being transferred is more than a specific amount called the annual gift tax exclusion amount. The annual exclusion amount for gifts is $16,000 per parent or donor for calendar year 2022 and $17,000 for 2023.

529 PLAN

Section 529 plans provide another valuable tax-advantaged savings opportunity. You can choose a prepaid tuition plan to secure current tuition rates or a tax-advantaged savings plan to fund college expenses. Here are some of the possible benefits of such plans:

  • Although contributions aren’t deductible for federal purposes, any growth is tax-deferred. (Some states do offer breaks for contributing.)

  • The plans usually offer high contribution limits, and there are no income limits for contributing.

  • There’s generally no beneficiary age limit for contributions or distributions.

  • You can control the account, even after the child is of legal age.

  • You can make tax-free rollovers to another qualifying family member.

To avoid gift taxes on 529 plan contributions, you must either limit them to your annual gift tax exclusion ($16,000 for 2022, up from $15,000 for 2021) or use up part of your lifetime gift tax exemption. Fortunately, a special break for 529 plans allows you to front-load five years’ worth of annual exclusion gifts and make up to an $80,000 contribution (or $160,000 if you split the gift with your spouse) for 2022. And that’s per beneficiary.

If you’re a grandparent, this can help you achieve your estate planning goals. (See the Case Study “A 529 plan can be a powerful estate planning tool for grandparents.”)


With a prepaid tuition plan, if your contract is for four years of tuition, tuition is guaranteed regardless of its cost at the time the beneficiary actually attends the school. The downside is that there’s uncertainty in how benefits will be applied if the beneficiary attends a different school.

A college savings plan, on the other hand, can be used to pay a student’s expenses at most postsecondary educational institutions. Distributions used to pay the following expense are income-tax-free for federal purposes and potentially also for state purposes, making the tax deferral a permanent savings:

  • Qualified postsecondary school expenses, such as tuition, mandatory fees, books, supplies, computer equipment, software, Internet service and, generally, room and board,

  • Elementary and secondary school tuition of up to $10,000 per year per student, and

  • Up to $10,000 of student loans per beneficiary.

The TCJA has permanently expanded qualified expenses to include elementary and secondary school tuition. But tax-free distributions for such expenses are limited to $10,000 annually per student. The SECURE Act further expands 529 plans by allowing them to be used to pay up to $10,000 of student loans per beneficiary.

The biggest downside may be that you don’t have direct control over investment decisions; you’re limited to the options the plan offers. Additionally, for funds already in the plan, you can make changes to your investment options only twice during the year or when you change beneficiaries. For these reasons, some taxpayers prefer Coverdell ESAs.

But each time you make a new contribution to a 529 savings plan, you can select a different option for that contribution, regardless of how many times you contribute throughout the year. And you can make a tax-free rollover to a different 529 plan for the same child every 12 months.


Coverdell Education Savings Accounts (ESAs) are similar to 529 savings plans in that contributions aren’t deductible for federal purposes, but plan assets can grow tax-deferred and distributions used to pay qualified education expenses are income-tax-free.

One of the biggest ESA advantages used to be that they allowed tax-free distributions for elementary and secondary school costs and 529 plans didn’t. With the TCJA enhancements to 529 plans, this is less of an advantage. But ESAs still have a leg up because they can be used for elementary and secondary expenses other than tuition—and there’s no dollar limit on such annual distributions. Another advantage is that you have more investment options.

ESAs are worth considering if you want to fund elementary or secondary education expenses in excess of $10,000 per year or that aren't tuition, or if you would like to have direct control over how and where your contributions are invested.

But the $2,000 contribution limit is low, and contributions are further limited based on income.

Also, amounts left in an ESA when the beneficiary turns age 30 generally must be distributed within 30 days, and any earnings may be subject to tax and a 10% penalty.