If you have been wondering how you best save for your child’s future, you’ve got the right post to get you started! Before I list the different options, know that there is NO wrong way to save for YOUR child. Your circumstances may make one option better than the other but that’s for you to decide what best fits your financial situation. I’ll list the pros and cons of each to help you better decide.
Here we go!
529 plan
This is also a tax-advantaged savings plan designed specifically for education.
Pros:
- Can be used for college and/or PreK for expenses. (Think study abroad opportunities)
- There are no contribution limits & plans can be transferred between children if one doesn’t choose a college
Cons:
- 529 plans have fees
- Must be used for educational purposes or there is a withdrawal penalty
Because I plan for all my children to go to college, they each have a 529 and in the case one decides to not go to school, it’ll be transferred to the sibling. No money lost.
Custodial Accounts (UGMA/UTMA)
An investment account that’s transferred to a minor at a certain age (Between 18-21). These accounts are typically opened because they are less restrictive on how the minor can use the funds in the account once it’s converted.
Pros:
- No Contribution Limits but no tax breaks for parents or child
- Flexibility on how funds can be used
- You can teach kids about investing early on
Cons:
- Parent has no control over funds once transferred to minor
- Calculated for financial aid purposes and may affect how much financial aid gets granted
The main difference between a UGMA and UTMA account is the assets allowed. UGMA has tighter restrictions but you can invest in stocks, bonds, and mutual funds – the assets most people invest in for retirement.
The UTMA allows more assets including physical assets, such as real estate.
Also, the UGMA automatically transfers to your child when they turn 18 years old but a UTMA account offers more options for transfer ages between 18 and 25.
Traditional Savings Account
Simple account at a retail or online bank that earns interest. Interest rates on this account typically follow the market and will fluctuate. The rate is still minimal compared to other savings accounts.
Pros
- Easily and readily accessible to get cash
- Less risky (not investing) and teaches kids how to save
Cons
- Low-interest return
- Limited transactions in a month; not to be used like a checking account.
This is better than nothing but if possible, select an account that would grow with meaningful interest.
Custodial Roth Account
An investment account for minors with earned income…meaning a child must have a job and earn wages.
Pros:
- Money grows in the account tax-free and under special circumstances, funds can be withdrawn before retirement.
Cons:
- Child must be working – an allowance does not qualify as wages
This is a powerful tool that takes into account compound interest. Because the funds grow tax-free, starting an account for your child early on could make them millions by the time they’re 35.
Educational Savings Account also known as an ESA
It’s a tax-deferred account created to help families save for educational expenses. This is NOT a 529 and I’ll explain the differences later.
Pros:
- Contributions can be used from Pre-K up until college
- Can be supplemented with a 529 PLAN
Cons:
- Limited to a $2,000 yearly contribution
- MUST be used for educational purposes or else there’s a penalty
Where can you open these accounts?
With your bank, a financial advisor, and even yourself! Fidelity, Vanguard, Schwab are popular firms that can facilitate opening a mix of these accounts.
No amount is too small to start. Your kids will thank you for investing in their future today. This is how you start generational wealth. By building small and building early.
