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 saving for kids early on. However, it’s critical to use the right account.
“A lot of parents view their home equity as a savings account,” says Jon Brodsky, CEO, USA of finder.com, a personal finance comparison website. “The problem with that is you don’t know if you’ll have access to that money.” If the housing market or economy fluctuates, there is no guarantee you’ll be able to sell your home or refinance to tap into its equity. Fortunately, you can secure long-term savings for your kids with a few strategic methods and accounts.
Here’s how to save money for your kids:
- Create a children’s savings account.
- Open a custodial account.
- Leverage a 529 college savings or prepaid tuition plan.
- Open a Coverdell education savings account.
- Use your Roth IRA.
- Open a health savings account.
- Set aside money in a trust fund.
Each savings account and method offers different benefits and disadvantages. Read on to learn more about saving money for your kids over the long term.
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.
“The whole teaching aspect of it is huge,” says Sarah Hussain, a product manager at Alliant Credit Union. Parents can set up recurring allowance transfers and children can take an active role in managing their money while earning some interest as well. At Alliant Credit Union, for instance, dividends are paid out on Kids Savings Accounts once the balance reaches $100.
As children age, they may be moved into teen checking accounts and issued a debit card. “The teen Visa debit card (for teen checking accounts) has lower spending and withdrawal limits,” Hussain notes. 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 “you deposit the money,” Brodsky explains. “You manage the account.”
Custodial accounts may be set up at banks such as Bank of America or brokerage firms like 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
When it comes to college savings, no account may be more valuable or more underutilized. “I’m shocked by the little use of 529 plans,” says James Mahaney, vice president, strategic initiatives for the financial firm Prudential.
Only 44% of parents with children ages 8 to 14 years old are using 529 plans, according to the 2018 Parents, Kids & Money Survey from financial firm T. Rowe Price. That’s despite the fact that 529 plans are widely considered the best savings vehicle for college expenses.
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, according to Brodsky.
Open a Coverdell Education Savings Account
Similar to 529 plans, Coverdell education savings accounts allow parents to set aside money for education expenses, including both college and private tuition for grades K-12. Contributions to a Coverdell account are limited to $2,000 per year and are not tax deductible. However, withdrawals for qualified expenses are tax-exempt.
Prior to the creation of 529 plans, Coverdell accounts were one of the best ways to save for a child’s college expenses. However, they have since fallen out of favor.
“My advice is: Why not use a 529 plan?” Mahaney says. A 529 plan doesn’t specify a contribution limit and may offer a state tax deduction, which are key benefits a Coverdell education savings account doesn’t offer.
Use Your Roth IRA
Dipping into retirement savings for your kids’ college tuition may not sound like a smart plan, but finance experts say there is no reason you can’t use a Roth IRA to cover education expenses. “Money needs to be saved for college and retirement anyway,” Mahaney says. Comingling the funds is OK as long as it’s done with proper planning.
A Roth IRA allows people to save after-tax dollars for retirement. In 2019, 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 59 ½ is tax-free, and the principal amount can be taken out at any time without tax or penalty. However, withdrawing any gains prior to age 59 ½ results in a 10% tax penalty. 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. 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 Mahaney says high-earning households can use a backdoor Roth IRA strategy to access these accounts. In 2019, the ability to contribute to a Roth IRA begins to phase out for married couples, filing jointly at incomes of $193,000. 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 $7,000 in 2019 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 $7,000. 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 children. “Most of us don’t have access to (one) because most of us are not that wealthy,” Brodsky says.
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.