Ask an advisor: Our baby is coming with a windfall. How should we invest?

March 26, 2024 4:50 PM

A mother-to-be in Maine is expecting a financial gift when her baby is born.

Welcome back to "Ask an Advisor," the advice column where real financial professionals answer questions from real people. The topic can be anything in the world of finance, from retirement to taxes to wealth management — or even advice on advising.

Having kids is expensive. On average, the total cost of raising a child to age 17 in the United States is about $310,600, according to the Brookings Institution — and that's before college. The average private college tuition in the U.S. is about $42,200, according to the U.S. News & World Report — or $168,800 for all four years.

Fortunately, a number of financial devices are available to help cover the costs. College savings accounts like 529 plans allow investments to grow tax-free, as long as the withdrawals are used for educational purposes. There are also UGMA (Uniform Gifts to Minors Act) or UTMA (Uniform Transfers to Minors Act) accounts, which are more flexible but don't offer the same tax benefits.

And of course, parents can also choose to save money the old-fashioned way — by buying bonds, investing in an index fund or stashing some cash in a high-yield savings account.

So what's the best way to save? The question becomes especially pressing when a baby is on the way. One reader in Portland, Maine is expecting not only a child but a generous gift from the grandfather-to-be. What should she do with the money? For guidance, she turned to the experts. Here's what she wrote:

Dear advisors,

My husband and I are having our first child. When our baby is born, my father-in-law is planning to give us each $14,000 — a total of $28,000.

We are already saving and are in pretty good financial shape, so we don't technically need this money. How should we invest it so it has the biggest impact later on for our child? Should we use this as a starting point for a 529 plan, invest it in an index fund or put it in bonds? Or simply save it in a high-yield savings account? Any suggestions?

Sincerely,

Pregnant in Portland

And here's what financial advisors wrote back:

Options within options

Kashif Ahmed, certified financial planner and president of

American Private Wealth

in Bedford, Massachusetts

Heartiest congrats, Pregnant in Portland! Babies are a blessing!

If you indeed do not need the money, then it is wise to invest it in a 529 plan. It will grow tax-free and come out tax-free as long as you use it for "qualified expenses" related to education.

Remember, you can buy an index fund or bonds, etc., inside of the 529 plan if need be, so don't think of your choice in that way. Having said that, there are plenty of 529 plans to pick from, so do your homework!

Another angle to consider is having your father-in-law open and fund the 529. This way you are not the owners and will not have to declare it when applying for college! Hope this helps.

The Maine advantage

Joseph Boughan, CFP and owner of

Parkmount Financial Partners

in Scituate, Massachusetts

For families in Maine, I usually recommend considering a 529 plan offered by the state of Maine. Maine provides matching grants up to a certain amount annually for contributions to a state-sponsored 529 plan for children born in Maine. Investigate this program and maybe spread contributions over a few years, optimizing the benefits.

Starting with heavier contributions to a 529 plan as early as possible maximizes its potential, especially if you want to prioritize their child's future education funding. This approach can be particularly advantageous if you're comfortable with the lower flexibility tied to 529 plans, but how much should go there depends on your exact education funding goals and preferences for flexibility that may be greater in a different type of account.

On cloud 529

Ralph Bender, CFP and founder of 

Enduring Wealth Advisors

in Temecula, California

Congratulations on your pregnancy!

Given all the unknowns about your child's future, it's hard to argue against a 529 plan. You'll avoid taxes while the account grows, and, depending on the withdrawal reason, you may never pay taxes on the gains.

The time horizon of the investment can be automatically aligned with your intended use of these funds through the use of target-dated funds without your ongoing investment management. It sounds like you've got your emergency fund in place. Unless you expect to use the $28,000 in the next few years, put it to work in the equity markets.

An ETF index fund could be a second choice, depending on (a) the index and (b) the account registration. The choice of index should be obvious, while the account registration might not be. Using a UTMA (or UGMA) registration irrevocably transfers the $28,000 to the child. This highlights another 529 benefit: the ability of the account owner (Mom and Dad) to change the beneficiary (baby) at any time in the future.

Think outside the box

Brian Seay, chartered financial analyst and founding partner at

The Capital Stewards

in Huntsville, Alabama

I've been having lots of discussions with clients lately about long-term savings for babies and small children. Here are a few thoughts:

Think beyond college! Your kids may have many kinds of major expenses in their 20s, like buying a house or starting a business. You can invest for all of those major life goals.

Remember that you do not have to pick one type of account! Many traditional savings accounts for children, like 529 plans, restrict the use of funds to qualified educational expenses. For those concerned about the future landscape of college education, we have been advising clients to split their savings between state-sponsored 529 plans and traditional brokerage accounts. The 529 plans can be used for traditional college expenses or rolled over to other children. The brokerage investments may be used for education if needed or used for other life goals like buying a home or starting a business.

Depending on your income, you may receive a state tax deduction for your 529 plan contributions. In Maine, that is limited to $1,000. That may be a good guide for how much to contribute to a 529 plan versus another kind of investment account.

For families with babies or young children, you have two decades or more to invest for their future. Historically, stocks have performed better than savings accounts and bonds over very long periods of time. We recommend using low-cost stock ETFs or index mutual funds to invest for your kid's future, regardless of the type of account you choose.