Strategies to Build Children’s Savings
It's no secret that raising children comes with a hefty price tag. New data from the Bookings Institution reveals that raising a child until they are 18 can cost approximately $310,605. This amount does not include college expenses. Saving money consistently from a young age can lead to big benefits later on, despite the initial financial commitment.
You can save money in various ways. This will help you set aside funds for different goals. It will also teach your child about saving and investing.
Take a closer look at these recommended accounts tailored for securing your children's financial future.
Savings Account
Teaching kids about money can begin by helping them open a savings account at a bank or online. Any adult can start this process for a child, no matter their age, as the primary or joint account holder. Contributions can be made effortlessly through various channels, including in-person deposits, digital transactions, or automated transfers from another account. Also, it's good to know that these accounts have FDIC insurance, protecting deposits up to $250,000 per person.
Both adults and minors can use the funds in the account. Parents often monitor the account closely. This presents an opportunity to impart valuable lessons about prudent saving and spending habits to their children.
Special savings accounts for kids have no minimum balance, no monthly fees, and good interest rates. These accounts also offer additional benefits on top of the basics.
Certificate of Deposit (CD)
If you're okay with not accessing your money for a while, a CD might be a good choice for you. CDs offer a fixed interest rate over a predetermined timeframe.
Short-term CDs may offer higher returns than cash in checking or savings accounts, despite being less liquid. High interest rates may not keep up with inflation. This could reduce the value of your savings in the long run.
It is important to be aware of this. People under 18 can't get CDs on their own, but adults can open CDs for them through a custodial account.
Custodial Brokerage Account
UTMA (Uniform Transfers to Minors Act) or UGMA (Uniform Gifts to Minors Act) custodial brokerage accounts empower adults to invest funds on behalf of children. These accounts can be established through banks or brokerage firms.
Using a custodial account is a smart way to save for a child's future or give them money. These accounts make it easy to invest in stocks, bonds, and mutual funds for your child's financial future. Custodial accounts do not have income or contribution limits like other savings options. It is important to consider the potential gift and estate tax implications of these accounts.
To avoid the federal gift tax, you can give up to $17,000 a year if you're single. If you're married and filing taxes together, the limit is $34,000.
The tax applies to giving money or property without receiving something in return. This rule is for the year 2023. Giving more than the limit doesn't always require you to pay gift tax. However, it does impact the child's lifetime gift-tax exclusion.
Contributions to a custodial account represent an irrevocable gift. Despite the parent's role in selecting investments, the assets within the custodial account legally belong to the child.
The money in this account is only for the child's benefit. It cannot be used for personal expenses or transferred to another person. This is different from savings accounts or CDs.
When the child reaches the age of 18 to 25, depending on the state, they can take control of the account. They are then able to use the money in the account as they see fit.
Conventional Brokerage Account
If you want more control over your child's money, you can open a brokerage account in their name. This account can be funded with money specifically set aside for them. This type of account offers more flexibility and options compared to custodial accounts. It allows you to make investment decisions on behalf of your child.
This setup allows your child to access the money at a young age and maintain control as they get older. Your child can use the money while they are still young. They can also keep control of the money as they grow up.
Later, you can transfer the account to your grown child when you believe they are prepared. Alternatively, you can designate them as the account beneficiary in case of your absence.
However, increased adult control also entails higher tax implications. When giving money to your child, remember that your earnings will be taxed at your rate, not theirs. Follow gift tax rules when transferring funds to them. Consequently, transferring all assets at once may not always be the most prudent course of action.
529 College Savings Plans
A good way to save for kids' education is with state-sponsored 529 accounts, which have tax benefits. Contributions to a 529 plan may not get federal tax deductions, but some states give tax breaks for contributions.
Money in a 529 account can grow without taxes. When you take out money for education costs, you don't have to pay federal income tax on it. Using 529 funds for non-education expenses can lead to taxes and a 10% penalty on earnings withdrawals.
Extra money in a 529 account can be moved to a different family member or used to pay off student loans. You can take out up to $10,000 for this. In 2024, 529 plans can transfer up to $35,000 into a Roth IRA. This is possible if the account has been held for the beneficiary for at least 15 years.
To use this strategy, the Roth IRA getting the money must be in the beneficiary's name. Rollovers are limited by yearly contribution limits. Contributions made into the 529 account within five years of the 529-to-Roth IRA conversion, along with any earnings on those contributions, are ineligible for conversion.
529 plans also offer distinct advantages in financial aid assessments. Student-owned accounts like bank or custodial accounts are more important in financial aid calculations than parental accounts. Student-owned bank or custodial accounts are prioritized over parental accounts in financial aid calculations.
Assets in 529 plans, considered parental assets, can increase a child's eligibility for financial aid. This is more significant than if the same funds were in an account owned by the child.
Roth IRA for Minors
Considering a retirement account as a vehicle for saving for a child may seem unconventional. Custodial IRAs and Roth IRAs can help secure your child's future. Your child must have earned income in the year they want to contribute.
It's important to know that money you make doesn't always have to come from a regular job with a W-2 form. It can also come from freelance work, such as babysitting or lawn care. Contributions are capped by earned income limitations, yet parents can augment their child's savings by matching contributions themselves.
IRAs offer several benefits for minors:
Compound interest over many years can help minors grow their savings in an IRA account.
Minors can benefit from tax advantages with a Roth IRA. This is because they typically earn less than adults. As a result, they may owe little to no tax on their contributions. This translates to the potential for tax-free growth on contributions, which may have accrued over years.
IRAs are for retirement savings, but minors can make penalty-free withdrawals before age 59½ in some cases. You can withdraw money from your account without a penalty for certain reasons. These reasons include paying for college tuition, purchasing your first home, or having a baby.
You can withdraw contributions made to a Roth IRA (excluding earnings) without penalties at any time, showing flexibility. This flexibility, coupled with exceptions for pivotal life moments, makes Roth IRAs versatile savings instruments.
Trusts
Trusts are not just for the wealthy; they can help save for children's futures.
A trust is a legal agreement. In this agreement, a third party holds assets for beneficiaries. The trust usually has rules about how the assets can be used.
Trusts come in two main types: revocable and irrevocable, each serving distinct purposes. Revocable trusts, commonly used for estate planning, can be altered or annulled by the grantor until their passing. Conversely, irrevocable trusts, once established, typically cannot be modified.
Parents can set up irrevocable trusts during their lifetime. They can name their children as the main beneficiaries. The funds in the trust can be used for important needs such as health, education, or basic support.
Alternatively, they could include similar provisions in a revocable trust, which transitions to irrevocable upon the parent's demise. Depending on trust terms, potential benefits include estate tax savings and creditor protection for trust assets.
Education and special needs trusts offer tailored solutions for children's financial needs. Education trusts let you take out money for school costs when your child is older, with more options than 529 plans. However, using investments for education within these trusts forfeits tax-free growth. Special needs trusts allow parents to allocate funds for their child's future care with conditions on disbursement.
Creating a trust needs careful thought. Costs vary from $1,000 to several thousand dollars based on complexity and assets.
Bottom Line
Allocating funds for the children in your life lays the groundwork for their future endeavors. Yet, while securing a financial cushion for them is crucial, it's just the beginning. It's important to teach good money habits early. Follow these tips to help raise financially smart individuals.
Sources:
https://www.fidelity.com/learning-center/smart-money/how-to-save-money-for-kids
https://money.usnews.com/money/personal-finance/family-finance/articles/how-to-save-money-for-your-kids
https://www.incharge.org/financial-literacy/budgeting-saving/teach-kids-to-save/
Disclosures:
This information is an overview and should not be considered as specific guidance or recommendations for any individual or business.
Asset allocation and diversification do not assure or guarantee better performance and cannot eliminate the risk of investment loss. As with any investment strategy, there is the possibility of profitability as well as loss.
This site may contain links to articles or other information that may be on a third-party website. Advisory Services Network, LLC is not responsible for and does not control, adopt, or endorse any content contained on any third-party website.
This material is provided as a courtesy and for educational purposes only. Please consult your investment professional, legal or tax advisor for specific information pertaining to your situation.
These are the views of the author, not the named Representative or Advisory Services Network, LLC, and should not be construed as investment advice. Neither the named Representative nor Advisory Services Network, LLC gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. Please consult your Financial Advisor for further information.