When a new child is born, those who love them begin to think about their future. Parents and loved ones dream of them growing up, going to college, achieving their goals and possibly starting a family of their own. It’s natural for those who care for a child to want to make a significant contribution to their future success, especially since many of them require financial resources.
The earlier you begin saving and investing for your child’s future, the more time there is to help them build their savings, and the greater the potential for growth through interest. However, there are many ways to save money for children and it can be difficult to know where to start.
In this post, we give you some information on savings options to help you decide what’s the most effective for your little one’s future.
Why is it important to start early?
The key to building a substantial savings for your children is to begin setting aside money as soon as possible after their birth. The length of time you save for is just as important as the amount you can afford to put aside. Starting today with a small regular amount, such as $20 per month, is more crucial than waiting for the perfect time. No matter how much you can afford, begin today by setting up a monthly automatic transfer and forgetting about it. This way, you will quickly accumulate a large sum of money.
Additionally, as soon as you start, your child’s money will benefit from the power of compounding, earning interest on top of interest. It’s like a snowball that gathers more snow as it rolls down a hill and grows bigger and bigger the longer it rolls.
Why should you consider investing?
If you’re saving for your child’s future, it’s beneficial to consider how your money can grow the most. Cash savings can be useful for short-term savings and easy accessibility, but interest rates are typically low meaning your child’s savings may not grow as much as they could.
Instead, investing could be worth considering. Over the long-term, your money has the potential to benefit from market growth and compound returns. Historically, investing has produced better returns than saving in the long run.
Top 5 ways to start saving for your child’s future
Open a custodial account
A custodial account is an investment account that allows families to save money for a child’s future. An adult, known as the custodian, opens the account and manages it on behalf of the child. The custodian makes all investment decisions for the child until they reach adulthood. Anyone can contribute money to the account, and all contributions are considered irrevocable gifts, meaning the money cannot be withdrawn once it’s deposited.
The assets in a custodial account legally belong to the child and they can access and use them for any purpose once they reach adulthood. There are two types of custodial accounts: UGMA (Uniform Gifts to Minors Act) accounts and UTMA (Uniform Transfers to Minors Act) accounts. UGMA accounts can hold financial assets such as stocks, bonds, mutual funds, index funds, insurance policies, annuities, and cash, while UTMA accounts can hold all the same financial assets as well as physical assets like real estate and collectibles.
In most cases, UGMA accounts are sufficient for families. The true advantage of custodial accounts over other options is their flexibility. With an UGMA or UTMA account, you can save and invest throughout a child’s life, and they can use the money to fund any goal they choose once they reach adulthood. These accounts provide young people with the financial support of their loved ones to pursue their goals and dreams. There are now also kids investing apps available which can help your kids with saving for their futures while you as the parent are very much in control.
Open a children’s saving account
An alternative to a custodial account is a savings account designed for children under 18, with joint ownership between the parent and child. These accounts are great and sometimes offer features such as educational content, birthday bonuses and cards for teenagers.
There are many advantages to opening a savings account for a child, such as:
- Helping them to learn, plan and focus on goals and priorities.
- Teaching them to save for what they want and wait until they can afford it.
- Showing them how their money can grow through compound interest.
It is important to keep in mind that learning financial responsibility takes time, so do not give your child more than they are ready to handle. Remember that a joint savings account gives your child access to the money, so some parents may want to choose an account that provides parental controls.
Start a 529 Plan
A 529 plan is a type of investment account for children specifically designed to save for a child’s education expenses. It offers tax advantages and flexibility, making it a popular choice for parents and grandparents.
With a 529 plan, you can invest in mutual funds or exchange-traded funds (ETFs) and the money grows tax-free if it is used for qualified education expenses, such as tuition, room and board, and books. The account is owned by the adult and the child is the beneficiary. There are two types of 529 plans: prepaid tuition plans and college savings plans.
Prepaid tuition plans allow you to purchase future tuition at today’s prices, while college savings plans offer more flexibility in terms of investment options. It’s important to note that each state has its own rules regarding 529 plans and there may be limits on the amount that can be contributed.
Set up a trust fund
A trust fund can help you to set aside money or assets for your child’s future and is usually set up by a parent or guardian and managed by a trustee who is responsible for investing and managing the assets in the trust.
One of the main benefits of a trust fund is that it can provide financial support for a child without giving them direct access to the money. This can be helpful if the child is not yet mature enough to handle large sums of money, or if you want to ensure the money is used for something specific.
Open a Roth IRA account
A Roth IRA for Kids is a type of retirement savings account specifically designed for children under 18. It offers the same benefits as a regular Roth IRA, but with a few differences. Since minors are not legally allowed to open brokerage accounts on their own until they are 18, a Roth IRA for Kids requires an adult to act as the custodian.
The custodian is responsible for managing the child’s Roth IRA, including making contributions, selecting investments, and handling distributions. The custodian also receives account statements. However, the minor is the rightful owner of the account and the funds in it must be used for their benefit.
Once the minor reaches a specific age, typically 18 or 21 in most states, the assets must be transferred to a new account in their name. A Roth IRA for Kids is a great way to start saving for a child’s future retirement, as it provides tax-free withdrawals, and the money can grow tax-free.
How much should you save for your child’s future?
The amount you should save for your child’s future depends on your specific goals for the money and your financial situation. Saving to pay for college education is one of the most common goals for parents. A general rule of thumb is to save 1/3 to ½ of the projected cost of the college or university that you hope your child will attend. The average cost of attendance (tuition, room and board) at a four-year public institution was $26,590 for 2020-2021 therefore you want to save enough to cover half the projected cost.
If your goal is to provide your child with a nest egg for important events like buying a house, getting married, or starting a business, the savings amount will vary. A financial advisor can assist you in creating a savings plan that aligns with your budget and goals.
Conclusion
It is never too early or too late to start planning for your child’s financial future. Even small savings or investments made consistently over time can add up and help your child achieve financial security as an adult.