How to Save Money for Kids: 5 Accounts All Parents Should Know About
Delaware Fatherhood and Family Coalition - Tuesday, March 09, 2021
How to Save Money for Kids:
5 Accounts All Parents Should Know About
Creating a financial foundation for your kids is essential. These are the accounts that will help you build it
By Daniel Kurt Mar 05 2021, 2:19 PM
The question of how to save money for kids has led to its fair share of sleepless nights and sour stomachs. There is just so much to figure out: How do I save for college? What accounts are best for creating a small nest egg for my kid? All the questions are good to ask because failing to give kids a cushion as they enter the real world can create a big emotional strain.
Consider this: More than six in ten college students graduated with student loan debt in 2019 and their average bill was $28,950, according to The Institute for College Access & Success. Couple that with chronically higher unemployment among recent graduates, and money issues can be a heavy burden for any young adult.
Building up savings now can help ensure that, when your children get a little older, they will not have to worry as much about crippling student loans or where their next rent payment is going to come from. So, to the question of how to save money for kids: Put a little bit a way as often as you can in the right account. Here are the five accounts to consider.
1. Custodial Accounts
Federally insured child savings accounts and debit cards can be a great way to encourage your son or daughter to build healthy financial habits. But you can also open a custodial account in their name, which may be an even more effective way to save long-term. Unlike child-managed bank products, kids do not control custodial accounts — more formally known as UGMA/UTMA accounts — until they reach legal adulthood. While they legally own the account, you serve as its “custodian.” Any money you put in is an irrevocable gift to the minor, so there is no takebacks.
Any funds deposited, from summer work money to Bat Mitzvah gifts, will stay put unless you make a withdrawal on their behalf. Once they turn 18 or 21, depending on your state, they will have a nice little reserve to fall back on.
2. Brokerage Accounts
Parents (and grandparents) looking for another smart way to save, with the potential for juicier returns, might want to think about a custodial brokerage account. Instead of their money sitting in a savings account generating tiny amounts of interest, you can invest in a range of stocks and bonds. There’s always a risk that those stocks can fluctuate in value, so you might want to steer toward less volatile securities unless you have younger children with a longer time horizon. And unlike 529 college accounts, earnings are taxable (although at the child’s tax rate). But if you’re looking for a vehicle with a lot of investment flexibility that puts you in the driver’s seat until they’re grown, custodial accounts are a pretty solid choice.
You can open a UGMA/UTMA account at pretty much any of the main brokerage houses, including TD Ameritrade and Schwab. There is also a new mobile app called Early Bird, which lets friends and extended family contribute to your child’s investment account for a small fee. It will not provide the same instant gratification as getting cash for their birthday, but in the long run letting the account grow will often provide a much bigger impact.
Whereas UGMAs and UTMAs are built around ease, setting up a trust for your kids can be a more complex (and costly) undertaking. That does not mean they don’t have important upsides, however. Custodial accounts give kids 100% control over the funds when they reach the age of adulthood. But handing an 18-year-old unfettered access to larger balances, especially, can be a recipe for disaster.
Trusts mitigate some of that concern by enabling parents to spell out exactly how they want the funds dispersed. Perhaps you want to give your children funds in a series of installments or would like for the assets to be used only on tuition. You can spell all that out in the trust.
Again, you do not get the same tax benefits as a 529, but the degree of flexibility that trusts offer is hard to match. Do not let the cliché about “trust fund kids” fool you— they can be a useful tool for middle-class families, too. 4. 529 Accounts
When it comes to heading off the massive tuition bills that likely awaits your kid in a few years, 529 savings accounts are still the go-to savings vehicle for most parents. The fact that students can withdraw money tax-free for qualified expenses—including room and board as well as required textbooks—is a big draw.
4. 529 Accounts
When it comes to heading off the massive tuition bills that likely awaits your kid in a few years, 529 savings accounts are still the go-to savings vehicle for most parents. The fact that students can withdraw money tax-free for qualified expenses—including room and board as well as required textbooks—is a big draw. But, depending on where you live, parents get a nice perk, too. More than 30 states let you deduct at least a portion of your 529 contributions, according to SavingForCollege.com, so you can often reduce your own state tax bill while helping your kids save. Do 529s give you all the investment flexibility you would have with a brokerage account? No. But the target date funds that most plans offer will keep a lot of parents happy. Keep in mind that 529 plans are not just for college, either. Families can withdraw up to $10,000 a year, tax-free, to help pay the cost of private elementary, middle or high school tuition.
5. Roth IRAs
If you have a teenager at home, you are probably more a lot more concerned about your retirement than theirs–and rightly so. But if you are already on track with your own investments, starting a Roth IRA for child who works part-time is not such a crazy idea. Part of it is simple math: because of the time value of money, even small amounts that they kick in now have the potential to experience decades of growth by the time they leave the workforce. And for younger investors, the tax benefits are especially potent.
Like any Roth account, kids cannot deduct contributions on their tax return. But unless your high schooler has a particularly lucrative job, they probably do not have a tax liability at this point anyway. Money grows tax-deferred and, long as they do not make any withdrawals until age 59½, they will not have to pay a penny to Uncle Sam on the back end.