You’d like to start saving for your child’s future. But you don’t know where to save – college savings plan, or some other type of account? Here are some tips to consider.
Setting a child up for their future
Many of my clients have children, or want to have children in the future. As part of their financial planning and annual savings goals, we consider saving for a child’s future.
The first point to consider is: what do you want the savings to be used for?
Of course, you want your child to have a good life in the future, but what specifically would you like them to use the money for? Many families want to help their child with the cost of higher education, which can feel out of reach without some family savings. Even if your child qualifies for financial aid, schools typically expect that parents contribute some amount towards the cost of education.
Some parents want to save to allow choices for their child in the future – whether that is starting a business; buying a first home; or advanced education.
The future of higher education
Saving for a child’s future is often, but not always, related to saving for college. The cost of college has historically increased at a faster pace than inflation. Saving for college when children are young can sometimes be the main way a family can afford to pay for college at all.
There is a lot of uncertainty around the cost of college right now, with the prospect of some student loans being forgiven by the federal government. Many European countries provide free or low-cost college education as part of their social services – what if something like that is enacted here? These are all uncertainties related to the future, and uncertainty can cause inaction – hesitating to take an action because it may not turn out to be the right action.
In the case of saving for a child’s future, however, the time value of money can provide a huge payoff. The younger your child is, the more time you have for your investments to grow and compound over time.
Savings accounts for children
Once you’ve thought about what you want the money to be used for, the next consideration is where to save.
Here are three different places to save for a child’s future.
- Bank savings account. Easy to use, very little earning potential due to low interest rates, minimal risk of loss. Some banks permit a minor child to be named on a bank account with limited functionality and paired with a parent account. For example, Chase First Banking (link opens in a new tab) permits minors age 6-18 to hold a debit card, with controls through the parent account.
- 529 College Savings Plan. Investable account, no taxes owed on earnings if used for education purposes, can choose amongst a few mutual fund-type investments depending on the plan sponsor (Illinois is a plan sponsor and also offers a tax benefit for contributions). If withdrawals are made for non-education purposes, 10% penalty on all withdrawals plus ordinary income taxes are owed on the earnings. The child is the beneficiary, and you are the trustee. Some states permit withdrawals for private school expenses up to $10,000 per year. Congress recently passed a bill that allows up to $35,000 of 529 funds to be rolled over to the beneficiary’s Roth IRA.
- UTMA account (Uniform Transfer to Minors Act). Investable account; taxes owed on all earnings; account is considered the child’s asset for financial aid purposes; ownership is held in trust for the child until they reach the age of majority, 21 in Illinois, at which time they can choose what to do with the account. The child is the beneficiary, and you are the trustee. After tax money is contributed, and funds can be withdrawn at any time for the benefit of the minor (not specifically limited to education).
There are advantages and drawbacks of each option. There are many considerations beyond what’s listed here. For example, if your child plans to attend college and may be eligible for need-based financial aid, assets in the name of the child are considered differently on the FAFSA than assets in the name of the parent.
How much to save
How much you save for your child is up to you. Do you want to cover the whole cost of a child’s private education? Do you want to be able to support them with getting an 2 year associate’s degree then moving on to 2 years at a state university? Do you want to save for a 20% down payment on a $200,000 first home? Using your client-stated assumptions, we can develop a plan that identifies the amount of monthly or annual savings you need to reach your goal by a stated end date.
First, though, consider your own personal situation. Are you setting yourself up for financial success? Are you saving enough for your own retirement? Do you have high interest personal debt like credit cards that you haven’t paid off?
There are many potential ways to pay for college or your child’s future, but only limited ways to fund your own retirement. Taking care of your own financial circumstances can be a benefit to yourself and your child that pays off over time.
So another question to ask might be, how much can you *afford* to save for your child AFTER you’ve saved for yourself? This may feel strange since many parents put their child’s needs first, but in this case, it’s wise to consider your personal circumstances first.
No time like the present
If you’re interested in saving for your child’s future, there’s no time like the present to get started. Even a small amount of savings each paycheck/month/year can add up over time. For example, imagine if you saved $100 each month for your child beginning at their birth. $1,200 savings per year with a 6% investment return could result in over $37,000 by age 18. $100 is less than many people spend on gas each month.
Talk to your financial advisor about what may be best for your situation.
