TurboTax certified public accountant (CPA) and tax expert Lisa Greene-Lewis joins Wealth host Brad Smith to discuss how to leverage tax-advantaged accounts to invest in your child's future.
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If you're saving your child's future, there are a few tax advantage accounts that you can put to work for that saving strategy, but it's important to know the pros and the cons of each. Here to explain and joining me now, we've got Lisa Green Lewis, who is the Turbo Tax CPA and tax expert. Lisa, great to have you here with us. Let's, let's just start with an account, many parents are probably familiar with a 529 college savings plan. What are the benefits to opening one for your child?
Yes, thank you for having me. So, first, the 529 account, um, that's great for qualified expenses for college education, so like your, uh, anything that um, you're not able to pay for with other, like, tuition. So you could pay for books, um, it could also be used for tuition, and then, um, something that's fairly new over the years, you could also use it to pay for K through 12 education up to $10,000.
So with this in mind, there are also custodial accounts. Explain the pros and the cons of a custodial account for us.
Yes, so a custodial account can also be used for anything that a 529 can't pay for, so for instance, um, you know, like room and board at college, or even a car, you know, you're able to pay for other items for your kids. Um, and you can contribute up to uh, the gift tax limit without paying any taxes. So the gift tax exclusion is up to $19,000 if you're single, up to $38,000, um, if you're a married couple, so you are able to contribute that much, and um, parents can pick the investments that they're that, that money goes into.
We, we've been hearing about and we know parents probably know this well, about this kiddie tax. Could you define what the kiddie tax is for us?
Yes, so, um, the kiddie tax, um, you would be subject to the kiddie tax with the custodial account because when you withdraw that money, um, it's considered income for your kids. And so you're taxed on, um, your, your kids are taxed on a certain amount up to, um, their tax rate, as well as the parents tax rate. And their income can go into your tax return as well.
And also here, some kids even qualify for a Roth IRA, uh, what should parents know about opening up a retirement account for their kids?
Yes, so as we all know, the earlier you start saving for retirement the better. And so with a Roth IRA for your kids, you know, they're getting those years of tax-free growth on income that they're able to withdraw when they retire. And with that, the contributions can also be withdrawn tax-free. Um, if they do withdraw for college, um, that income can be taxable, but it is also a great way to save for college.
So those are three great accounts for parents to keep in mind. Could you also tell us some of the disadvantages that parents should be mindful of with 529s, custodial accounts, and Roth IRAs?
Yes, so the disadvantage with a 529, um, states have so many different rules on these, um, and there are also restrictions on the qualified expenses. It's mainly for college expenses. Um, you can withdraw for other things besides college, but you would be taxed on those withdrawals, as well as a 10% penalty. And then, um, just the variations of, uh, of the different types of programs that they have. It varies by state.
Lisa, great to have you here with us. Thanks for breaking down some of these accounts.
Thank you for having me.