Kids realize early in life that money has value and can get them things they want. But that doesn’t always mean a child will eventually understand the true value of money and how to grow their savings responsibly. Parents can help set their children on the right path toward financial security by teaching them about investing — while bearing in mind the potential tax impact.
“Money doesn’t grow on trees” is a cliché that parents have been using for years. Yet one of the benefits of getting children involved in investing is that you can show them that money can, in fact, be grown. It also teaches them that money isn’t just for spending, which many children can assume after years of watching parents shell out dollars at retail stores and restaurants.
Another benefit is teaching a child the simple lesson of compounding. For example, present them with two hypothetical — and, preferably, cleverly named — investors. Then tell the tale of how the one who starts investing earlier rather than later can save more and reach his or her goals sooner.
Doing so can help a child see an investment as a small seed that can grow into something much bigger. It can also remind you that it’s never too late to start investing yourself.
A risk of investing for kids is that they’ll simply be overwhelmed by the amount of information and number of rules involved. Some, more detail-oriented children may enjoy analyzing and following individual stocks. But others may be better off getting into mutual funds and simply watching their “teams” compete in the market.
Still other kids may not be ready for the investment step at all. Many may need to start off learning about the power of saving money. Then, when that lesson is clear, move on to taking a small piece of their savings and investing it.
It’s critical that parents understand the tax impact of a child’s investment. In some cases, you may need to include your child’s investment income on your tax return. (Investment income typically means interest, dividends, capital gains and other unearned income, such as from a trust.) In others, your child may have to file a return.
Generally, if a child has investment income of $9,500 or more, he or she must file a return. For children whose total interest and dividend income is less than $9,500, parents can usually file on their behalf and include that income on their return. (Note: The $9,500 figure may change for 2013 tax returns but, as of this writing, a revised amount wasn’t available.)
But that $9,500 amount isn’t necessarily the only trigger for action. Should your child earn investment income of more than $2,000, special rules may apply. Namely, your tax rate could apply to part of that income instead of the child’s tax rate.
Guiding your child through the world of investing can be a learning adventure that lasts a lifetime. But, as you can see, there are risks and tax effects that pose a challenge to both student and teacher.