You can never be too early when planning for a loved one's financial future. While it may not seem urgent now, the power of compound growth should not be overlooked. It can significantly reduce financial barriers, giving our loved ones a real chance to follow their dreams without the worry of financial limitations.
Summary
- UGMA’s: Provides unmatched versatility for future use, with no restrictions on fund application, whether for education or other life endeavors.
- Coverdell ESAs: Offer tax-free growth for a range of educational expenses from K-12 to higher education, but with contribution and income limitations.
- 529 Plan: Ideal for those certain of a child's educational path, with high contribution limits and tax-free growth for educational expenses.
The Power of Compound Growth
Capital appreciation, when combined with compound interest, can yield astounding results.
Consider this: An annual investment of $2,000 in the stock market (S&P 500) for a minor, with an 8% expected rate of return, would grow to about $91,524 by the time two decades have passed. If you increase your yearly contributions to $4,000, you're looking at a substantial fund of over $183,000 by the time your loved one celebrates their twentieth birthday!
🤔 What would you have done with that opportunity?
In this article, we stack side-by-side three popular investment accounts for minors: UGMA’s, 529 Plans, and Coverdell ESA’s.
Let’s get started!
Spoiler Alert: We've found that a UGMA account often offers the most flexibility, which is one of the reasons EarlyBird champions these accounts.
“Lack of money is the root of all evil.” -Mark Twain
UGMA Investment Account
UGMA accounts are at the top of our list for their incredible versatility. These minor investment accounts aren't limited to educational expenses — they're a financial springboard for any aspirations a young person might have, education-related or otherwise.
At EarlyBird, the choice to utilize UGMA accounts was deliberate. We recognize that not every path to success includes a college degree. Perhaps, upon reaching adulthood, the young beneficiary is ready to launch a start-up or follow a non-traditional career path that doesn't require higher education.
Maybe your loved one wants to spend two years in the Peace Corps or live in an attic in Paris for a year scrapping away on the next great novel. UGMA’s cover all expenses that accompany non-traditional career paths.
Additionally, consider the chance that, in two decades, the US will follow Europe's lead and offer free higher education. How beneficial would funds in a 529 or Coverdell account, which are restricted to educational expenses, be to your loved one then?
If you need a little help getting started investing in your loved one’s future, check out our article dedicated to investing in stocks for kids.
At EarlyBird, we make it easy for anybody to contribute to a minor's financial future. When you’re loved one is sipping a Cafe Americano on the terrace of that Parisian cafe in twenty years, they’ll be able to scroll through a collection of heartfelt video messages that accompany every generous contribution to their account.
UGMA Fast Facts
- Annual Contribution Limit: Unlimited; gift tax above $17,000
- Age of Withdrawal: 18 or 21 (varies by state)
- Tax Rate: First $1,100 of unearned income tax-free, next $1,100 taxed at child's rate, then at trust rates
529 Plan
529 College Savings Plans are the most popular account type when it comes to investing in America’s youth. These plans offer completely tax-free withdrawals for qualified education expenses. Examples of education expenses include:
- Tuition
- Room & Board
- Textbooks
- Some K-12 education expenses
In 2023, you can contribute up to $17,000 per child to 529 plans without hitting gift tax limits, and if you're married, that amount doubles to $34,000 per child. This allows for significant tax-free educational savings.
It's worth noting that 529s are tailored exclusively for educational expenses. Considering that roughly only 38% of America's youth graduate from college, a 529 plan may restrict access to funds for life opportunities beyond the classroom.
529 Fast Facts
- Contribution Limit: Varies by state, up to $550,000
- Age of Withdrawal: No age limit
- Tax Rate: Earnings grow tax-free and are tax-free when used for qualified educational expenses; non-qualified withdrawals incur 10% penalty
Coverdell Education Savings Account (ESA)
A Coverdell Education Savings Account (ESA) is a tax-advantaged savings account that allows for tax-free growth and withdrawals for a broad range of educational expenses
Coverdell’s and 529 Plans have a lot in common but are distinguished by a few key differences:
- Income Restrictions: Coverdell - Yes; 529 Plan - No
- Contribution Limits: Coverdell - $2,000/year; 529 Plan - up to $550,000 total
- Qualified Expenses: Coverdell - K-12 and higher education; 529 Plan - Higher education, some K-12 tuition
- Age Restrictions: Coverdell ESA - Use by age 30; 529 Plan - None
As mentioned previously, a 529 Plan is known for its high contribution limits, making it a great option for college savings and certain K-12 expenses, without any income caps on who can contribute.
Coverdell ESA’s, on the other hand, cater to a broader range of educational costs starting from K-12. Coverdell’s, however, are limited by both lower contribution caps and contributor income limits.
For those who intend to save a modest amount for a child’s educational future, a Coverdell might be a suitable choice. Still, it's crucial to be aware that these contribution limits could pose limitations down the line. Take, for instance, an EarlyBird customer who received a hefty $60k in contributions to their UGMA account – this would be impossible in a Coverdell!
Coverdell ESA Fast Facts
- Contribution Limit: $2,000/year
- Age of Withdrawal: Funds must be used by 30th birthday
- Tax Rate: Contributions are non-tax-deductible; earnings and withdrawals are tax-free.
529 vs Coverdell vs UGMA
The below table highlights the pros and cons for our selected minor account types.
Final Word
If you're 100% certain that your loved one's path includes college, then a 529 or Coverdell is your best bet. But if there's a chance they might choose a different direction, a UGMA account is a wise choice.
It's also perfectly fine to hold both a 529/Coverdell and a UGMA account simultaneously!
For more information on investing for kids, check out our complete guide: Gifting Money to Children.
This page contains general information and does not contain financial advice. All investments involve risk. Any hypothetical performance shown is for illustrative purposes only. Actual investment performance may be different for many reasons, including, but not limited to, market fluctuations, time horizon, taxes, and fees. Please consult a qualified financial advisor and/or tax professional for investment guidance.
