Starting a family almost always means parents will need to make adjustments to their finances. From buying birthday presents to paying fees for extracurricular activities, raising kids can be costly.
“Children tend to be pretty big budget disrupters,” says Monica Sipes, senior wealth advisor with Exencial Wealth Advisors in Frisco, Texas. Whether you want to teach your child smart money-management strategies, help them pay for college or set them up for financial success as adults, it’s important to jump-start savings for kids early on.
However, it’s critical to use the right accounts. The best way to save money for kids will depend on your goal. Here are seven options to consider:
- Create a children’s savings account.
- Open a custodial account.
- Leverage a 529 college savings or prepaid tuition plan.
- Use your Roth IRA.
- Open a health savings account.
- Set aside money in a trust fund.
- Teach your kids the value of saving money.
Create a Children’s Savings Account
Most banks and credit unions offer children’s savings accounts, which parents can co-own. These accounts can help children develop the habit of saving, rather than spending, all their money.
“It can be a really valuable tool,” says Brian Jass, advisor with Great Waters Financial in Vadnais Heights, Minnesota. Whenever his young daughter receives a gift of money, he always makes a point to encourage her to save a portion of it.
Rather than paying a cash allowance, parents may want to set up recurring allowance transfers. This can encourage children to take an active role in managing their money while earning some interest as well. As children age, they may be moved into teen checking accounts and issued a debit card. Parents remain co-owners of teen accounts to help them oversee and assist with money management as needed.
Open a Custodial Account
A custodial account may be best for those who want to save money for their children but don’t want them to have access to the cash until they are adults. The money is held in the child’s name, but parents can deposit money and manage the account until the child reaches the age of majority. “(These) can be helpful if (parents) are saving for another purpose outside of college,” Sipes says.
Custodial accounts may be set up at banks such as Bank of America or brokerage firms like Charles Schwab and Franklin Templeton. They are governed by the Uniform Gifts to Minors Act and the Uniform Transfer to Minors Act. The accounts allow children to own securities or other assets that may otherwise be off-limits for them.
While custodial accounts don’t provide the same tax benefits as other college savings vehicles, they may be a good choice for parents who aren’t sure their child will go to college or who want to provide a financial gift upon adulthood. Once a child reaches the age of majority as governed by their state, money from a custodial account is transferred to him or her.
Leverage a 529 College Savings or Prepaid Tuition Plan
Financial experts seem to universally agree that a 529 plan is the best way to save money for child college costs. “For education, it’s tough to beat a 529,” Sipes says. The accounts come with tax benefits, and many plans feature low fees.
There are two types of 529 plans. One is a general college savings plan that allows parents to put money aside into an account that can be used at any school, including private K-12 institutions. Some states provide a tax deduction for contributions to their state’s 529 plan, and withdrawals used for qualified education expenses are exempt from federal income tax.
The other option is a prepaid tuition plan that locks in current tuition rates for public institutions. While the ability to lock in tuition rates is a valuable benefit, the college savings option offers more flexibility and may be a better choice for most families.
Use Your Roth IRA
Dipping into retirement savings for your kids may not sound like a smart plan, but it can be OK so long as it’s done with proper planning. Roth IRAs can be a smart choice if you’re looking for the best savings plan for child expenses that offers flexibility.
A Roth IRA allows people to save after-tax dollars for retirement. In 2021, workers younger than age 50 can save up to $6,000, while those age 50 and older can contribute $7,000. Money withdrawn after age 59½ is tax-free, but withdrawing any gains prior to that age results in a 10% tax penalty.
The flexibility with a Roth IRA comes from the fact that the principal amount can be taken out at any time without tax or penalty. “It doesn’t necessarily have to be for retirement either,” Jass says. Depending on your age, you could use some or all of the money placed into a Roth IRA for your child’s college education or other expenses. However, if you plan to deplete the account, make sure you have another source of retirement savings, like a 401(k).
There are income limits for those who want to contribute to a Roth IRA, but high-earning households can use a backdoor Roth IRA strategy to access these accounts. In 2021, the ability to contribute to a Roth IRA begins to phase out for married couples filing jointly at incomes of $198,000. To get around this limit, they can make a non-deductible contribution to a traditional IRA and then convert to a Roth IRA.
Open a Health Savings Account
If you have adult children who are covered by your high-deductible health insurance plan, a health savings account is another option to consider. “It’s the only triple tax-free savings tool in America today,” says Shobin Uralil, co-founder and COO of Lively, an online health savings account provider.
Those with a qualified high-deductible family health insurance plan can contribute up to $7,200 in 2021 to a health savings account. This money is tax-deductible, grows tax-free and can be withdrawn tax-free for qualified medical expenses. At age 65, money can be withdrawn for any reason and only be subject to regular income tax, the same as a traditional 401(k) or IRA.
While a married couple can only open one health savings account, each adult child covered by a family plan can open their own account and anyone can make contributions totaling up to $7,200. While there are limitations to the use of this money, having an account dedicated to health care costs can help smooth your child’s transition into adulthood. “The best time to fund your HSA is when you don’t need the money,” Uralil says.
Set Aside Money in a Trust Fund
Though not as common, a trust fund is another way to save money for kids. A trust fund can be set up with any amount of money, but it usually doesn’t make sense unless you have a large amount of cash to deposit into it. An attorney needs to draw up the trust documents, and someone must be appointed to manage the money.
Still, for wealthy families, a trust fund offers more control over disbursements, protects cash from creditors and ensures a child’s assets aren’t split during a divorce.
Teach Your Kids the Value of Saving Money
While creating savings for kids is important, parents shouldn’t overlook the value of teaching children to set aside money for themselves. While opening a children’s savings account is one way to do that, even young kids can be taught more advanced concepts such as investing.
One way to do that is give children a say in stock purchases. Some investment firms, such as Schwab, allow the sale of fractional shares which makes it possible for even those with limited money to own a part of popular companies such as Disney and Apple. “For some kids, that may be more exciting than buying another toy at Target,” Sipes says.
Meanwhile, the Stockpile app issues gift cards that kids can redeem for stock in their favorite company. Custodial accounts on the app allow kids to have their own log-in to manage their account and request stock trades, which their parents then approve. Then, over time, children can see how the value of the money they save and invest changes.
Parents should also make a point to include children in money discussions when appropriate. These may include, for instance, discussing the cost of household expenses or planning to save for a vacation. Finances seem to be a taboo topic in many households, but Sipes says it’s extremely important for kids to see and hear these discussions to help them make smart money decisions when they get older.