Toys and clothes will come and go, especially for younger children. If you want to give a gift that will last, think about investments. These gifts may not be the most exciting at the time, but they could end up being the most appreciated in the future. In this article, you’ll learn the best options when it comes to contributing money to a child’s future.
Nearly one-third of all American students go into debt to pay for college. The average amount of student loan debt per person reached a record high of $38,792 in 2020. If you want to help your beneficiaries avoid or reduce this burden, look at opening tax advantaged college savings account.
A 529 plan is one of the most common ways to save for education expenses. It’s a tax advantaged account, which means your money grows tax deferred and you can withdraw it tax free when used for education expenses. In Illinois, contributions to the plan are tax deductible up to $10,000 per year ($20,000 if married and filing jointly). The negative of a 529 plan is you’ll pay taxes on your earnings, plus an additional 10% penalty on withdrawals for non-qualified expenses. Instead of paying the penalty, you are allowed to switch the beneficiaries to someone who will use it for education expenses.
Contributions at a young age have the potential to grow throughout their childhood. For example, if you make an initial deposit of $500, and contribute $200 yearly, that money could grow to over $10,000*. Future contributions could be for birthdays, graduations, holidays, etc. Also, 529 plans allow third party contributions, regardless of who owns the account. Meaning anyone including grandparents, aunts, uncles, or friends can help contribute.
*Assumes 20-year period with 7% annual return
A custodial account can be another great way to give a financial gift. With this type of account, the custodian will have full control of the account until the minor reaches the age of majority (Varies by state, 21 in Illinois). One advantage is that there are no contribution limits or penalties for withdrawals. The only rule is that any withdrawal must be used for the benefit of the minor. These accounts are established under the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA).
Unlike the 529 plan, you cannot change the beneficiaries. Once a deposit is made it becomes irrevocable and property of the child. The account holdings count as an asset for the child and could reduce their ability to access financial aid for college.
Any investment income on the accounts such as dividends, interest, or earnings are taxed. As of 2021, the first $1,100 is untaxed and the next $1,100 is taxed at 10%. Anything over $2,100 is taxed at the parents’ rate. Once the minor reaches age of majority, the account earnings will be subject to their tax bracket.
Savings bonds are a more conservative option for gifting money. These bonds represent a loan to the U.S Government. In exchange, the bonds pay back your initial investment plus interest. Savings bonds are available as Series EE or Series I, both accrue interest monthly and compound interest semiannually. Earnings on both bonds are subject to Federal income tax.
Series EE bonds purchased after May 2005 earn a fixed rate of interest. Regardless of the rate, the bond comes with a guarantee to earn at least double your investment plus interest. The interest rate is fixed for 20 years and after the 20th year the government can adjust it. For bonds issued May 2021 – October 2021, the rate is 0.10%.
Savings I bonds earn a combined fixed interest rate and a variable inflation rate that is adjusted semiannually. The rate for bonds issued May 2021 – October 2021 is 3.54%.
Digital savings bonds can be purchased through the Treasury Direct website. In a calendar year, you can buy up to $10,000 in U.S. savings bonds. You can no longer purchase paper Series I and EE savings bonds from banks and credit unions.
529 plans, custodial accounts, and savings bonds are just a few of the variety of financial gifts that can be given. Other gifts you might consider are:
Certificate of Deposits (CDs): These provide a fixed rate of return in exchange for a customer leaving a lump sum deposit untouched for a predetermined period. As of October 2021, the best rate for a 5-year CD is 1.15%.
Collectibles: This covers a wide variety of options. Some of my personal favorites are sports memorabilia and rare coins/currency. For others, this could be antique furniture, comic books, stamps, etc.
Jewelry: Potential ideas could be a necklace, chain, or a ring.
Cash: Everyone likes getting cash as a gift.
The type of gift you choose depends on your goal(s). If your primary goal is to help pay for education, 529 offers the greatest tax advantages and control. If you want to transfer wealth with less restrictions on withdrawals, then a custodial account would be a better option. For everything else, savings bonds, alternative investments, and cash are all good financial gifts.
This post is dedicated to my two-week-old niece who inspired the thought.
Disclaimers and Sources:
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