A little more than a year ago, I wrote an article about whether or not to invest our babies' money. The advice was overwhelming. Since they aren't going to use this money (mostly birthday cash from relatives/friends) for quite some time, it should be invested on their behalf.
Unfortunately, I lived down to my Lazy name. I didn't invest the money. On the bright side, they probably haven't lost any money as I would have split it between domestic and foreign stocks. The domestic portion would have done well and the foreign, not so well.
It's time to fix that. I'd like to set-up a brokerage account for them. Even a year later, at ages 1 and 2 they won't be needing the money for years. I called up USAA with a very simple plan: open up a brokerage account in each of their names, transfer their money into, buy an ETF, and watch it grow over the years.
Since they are under the age of 18, I can't open an account in their name. That makes legal sense, but I didn't anticipate it. It appears that there are two options:
- Open two brokerage accounts in my name. In this case I'd manage them as if they were my own.
- Open a UGMA/UTMA account for each of them. In this case, there's some special tax treatment that I'd have to understand.
So let's look at the two:
Brokerage Accounts in my Name
It doesn't feel right to have the money in my name. It's their money.
From a financial perspective, this money should be taxed at their income levels... which would be significantly less than mine even in the future.
Pros and Cons of the UGMA/UTMA
Evan from My Journey to Millions highlights some of the problems with UGMA/UTMA accounts:
1. When it comes time to calculate financial aid, it's going to show up as their money.
2. The children receive the money at age 18 or 21 (depending on the state).
I don't have a problem with either of these. The money should show up as theirs when it comes to financial aid. I don't care if they spend it before the age of 18 or 21. In fact, I'm hopeful it will grow to be enough to buy a car at age 16. Then they can say, "Hey, good job investing my money when I was 2, Dad!" (I won't hold my breath on that one.)
What I have a problem with is that a significant portion could be taxed at the parents' marginal tax rate. Reading this this tax codes makes my head explode. As I understand it, this was prevent a loophole where parents were using this to shelter their money.
I don't think money that was gifted to them by friends and relatives should be subject to our tax rate, but it seems like it is.
So What Should I do?
I don't know if this is an answer to my own question, but I'm thinking that this whole issue may be a moot point. I intend to buy an ETF in the brokerage and hold it for a long, long time. I think that would qualify it as a long-term capital gain and not subject to marginal tax rates.
It makes me think that I should just open the brokerage account in my name and manage it myself. Just to be sure a call to my tax advisor may be of help.
In case you were wondering, I'm thinking of buying Vanguard Total World (VT) as my one stock for them. The reason is that this provides great growth potential and diversity (in a domestic and foreign sense) with minimal risk (due to the long-term outlook). Also, since they don't have a lot of money to invest, I want to keep the brokerage commissions at a minimum (a $10 commission is 1% of a $1000 balance). That rules out buying a portfolio of stocks.
So what do you think? Let me know in the comments below.
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