The Best Way to Save for a Child's Future
One day your child will start their way in the world, and as a parent, there are things you can do to help invest in your child’s financial future. While some children may continue their educations going on to college, others may choose a different path looking for a job after High School graduation. Both paths are admirable, with different financial tools a parent can use to help their child on whichever journey they end up taking. Read on to look over options to start planning for your child’s major financial events.
You can open a savings account for any child who has a Social Security number. As your child gets older, help them understand that the purpose of a savings account is to have a safe place to keep their money. As a reward for keeping their money in a bank, they will earn interest, which will be deposited monthly into their account. Whether your child is going to college or not, this option will set them up for success in saving for future needs and, eventually, paying their bills.
Introduce the idea of a budget. See if there is a special item your child wants to buy. Then, help them figure out how to save up for the item. For example, if a Lego set costs $30 and they set $5 a week aside from their allowance, it would take five weeks to purchase the set.
A child in their teens may benefit from having both a savings and checking account. Help your teen learn how to use a debit card and balance a checkbook. Minors under 18 need a parent or guardian on their accounts, so as a joint owner, you can track their spending through your own online banking to ensure the account is in good standing.
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Many credit unions and banks offer youth custodial savings accounts, referred to as a Uniform Transfers to Minors Act (UTMA) account. With an UTMA account the custodian manages the account, meaning that the minor cannot access the funds, get balance information, or withdraw money. Only the custodian is authorized to conduct transactions on the account. This type of account may be a good option for parents who wish to save money that their child cannot touch until they are 18 or 21, depending on state law.
A 529 plan is a tax-advantaged investment used to pay for educational expenses for kindergarten through college. The funds can be used to cover room and board, tuition, and related educational expenses such as textbooks. If the money is used for K-12 expenses, you are limited to withdrawing up to $10,000 annually.
Contributions into the plan are after-tax with tax-free withdrawals if they are used for qualified educational expenses. The IRS does not specify contribution limits, but there are maximum contribution limits per each state. In Vermont, the maximum contribution limit is $352,800, according to the Vermont Student Assistance Corporation (VSAC). Anyone can contribute to the plan. It is not limited to parents, so anyone can make a gift.
COVERDELL SAVINGS ACCOUNT
Coverdell accounts have tax-advantaged options to help save for kindergarten through college as well. Money contributed into a Coverdell can be withdrawn tax-free if used to cover qualified educational expenses such as tuition, fees, books, and supplies and equipment. Up to $2,000 per child per year in contributions can be made in this account by a parent, grandparents, or anyone else who would like to contribute. The final distribution from a Coverdell account must be used before age 30, but if any funds remain in the account, they can be transferred to another beneficiary under age 30.
In the past, family or friends would go into their financial institution to purchase a savings bond to give as a gift. Nowadays, credit unions and banks do not issue bonds, but only help their members redeem U.S. Treasury bonds. You can still purchase a bond when you create an account with the TreasuryDirect for your child.
For children under 18, a parent or guardian will need to create a minor account, which will be linked to their own TreasuryDirect account. The parent/guardian can purchase, redeem, receive gift deliveries, and perform other transactions on behalf of the minor. Once your child turns 18, the account can be disconnected from the parent/guardian’s account so the minor can establish the account as their own. The most common type of bond purchased is a Series EE Savings Bond, which will earn interest for up to 30 years or whenever it’s cashed in. Unlike a 529 Plan or Coverdell Savings Account, bonds are not exclusive to education, but can be used for anything. If a bond is used for educational expenses, it must be used in the same tax year the bond is redeemed to receive a tax break on bond payments.
INDIVIDUAL RETIREMENT ACCOUNT
Typically, money set aside in an individual retirement account (IRA) is used to help supplement your income during retirement. This should never be your first choice because every withdrawal shrinks the nest egg you will need when you no longer have the capacity to earn. However, if you’d like to dip into those funds before retirement, there are certain penalty-free withdraws you could do to help your child with major life events.
One type of qualified withdraw would be to pay for higher educational expenses (attending a college, university, or a post-secondary school). The covered expenses would be things like tuition, books, fees and school supplies. If a withdraw is made for this purpose, you will not be liable for the 10% early withdraw fee. To investigate more specific details on withdrawing money for attending college, the IRS website Retirement Topics Tax on Early Distributions | Internal Revenue Service (irs.gov) or a tax advisor would be good resources to consult.
Investing in your child’s future comes in many forms, from teaching them money management skills by opening a bank account to providing them with money to start the next chapter of their lives. The bank account, to me, is the crucial first step that can set other financial goals in motion, as it’s how your child starts transacting with the world around them, becoming a part of the economy. Learning how to manage money can help your child achieve their own financial goals, setting them up for whatever future success comes their way.
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The views and opinions expressed in this blog are those of the authors and do not necessarily reflect those of VSECU.