Intro: Savings for Children | How to Develop the Best Savings Plan for a Child
A childhood friend of mine recently became a grandmother, and her Facebook account was awash with pictures of all the adorable outfits and pink toys she has purchased for her new granddaughter.
As any good friend does, I paid her and her daughter a visit to see the new addition to the family, and, while we were talking, I asked her about what child savings plan options she had been exploring for her future.
Her answer: she hadn’t thought about creating a children’s savings plan at all.
Most parents know the importance of building a savings plan for children, but with so many options, they struggle to find which one is the right choice.
Savings for Children
It can often be challenging to find the best way to save for a child, so we will take a look at some of the options that are still around from when we were children and compare those to the more current options that are available to help you find the best savings plan for your child.
Let’s start with our old friend, the Uniform Transfer to Minors Act, or UTMA. Originally, there was also the option of the Uniform Gift to Minors Act, or UGMA; however, the majority of states have now adopted the UTMA as the only available option.
Creating a UTMA account lets you begin your child’s savings plan and allows you to be the custodian until your child is considered an adult. It is also a relatively easy way to start saving for your child’s future, but is it the best child savings plan?
One concern of parents is the loss of custodial management over the child’s savings plan when their child reaches the age of 18. When the minor becomes an adult, the custodian and any contributors to the UTMA will have no control over the use of the money as it will be under full control of the child at that time. Additionally, the funds placed in a UTMA cannot be transferred to another beneficiary.
At the onset, UGMAs represented a way for parents to put away money for their child’s savings and decrease the taxes they would pay if they used their own investment accounts as a way to set up savings for their children.
Over time, the laws that allowed parents to use a UTMA to set up child savings account with little tax consequences have changed. This means there is really little remaining benefit in setting up a UTMA as a child savings plan. Even if your income makes your child ineligible for financial aid, there are more modern and better options to set up child savings account for your family.
US Treasury Savings Bonds
If you are still looking for something that is more secure and carries minimal risk, you can always invest in US Treasury bonds for your child’s savings plan. While the return from savings bonds is often small, if you are concerned about the security of your children’s savings, they may be a viable option for you. In addition to being safe, savings bonds also offer tax advantages, and educational bonds offer very low to no taxes on growth.
You can also invest smaller amounts, as low as $25, which would allow you to set up a plan for your child’s savings and still meet your budget. You can also purchase Treasury bonds online, making it more convenient. You also do not need an investment professional to help you with the purchase of savings bonds for your child’s savings plan, so you would not incur any additional fees during the purchase process.
While savings bonds offer slower growth, combined with other investments, they could benefit you as you build your savings plan for your child. Given the pace of growth and overall value of a savings bond, it would not be sufficient to use them solely for your child’s savings account. If you are looking for significant growth, however, savings bonds would be the most advantageous option for your child’s long-term saving goals.
Now we will start to look at some of the more current child saving plans that are available – first we have the 529 plan. This child savings plan is designed to provide tax advantages and other incentives to make it easier for families to pay for college for a child or grandchild.
Child Savings Plan
The main reason this is one of the best child savings plans is that the earnings are not subject to federal tax, and they are usually not subject to state taxes when the earnings from the child’s savings are used for qualified expenses that are directly used for the child. These include items like fees, books, and room and board as well as tuition.
While many find the 529 to be the best way to save for their child, it is important to know which 529 is available where you live. There are two options when considering your child’s savings: prepaid tuition plans and child savings plans. Each state can establish its own plan, and each plan may differ slightly. States are permitted to offer both plans while a qualified educational institution can only offer the prepaid tuition option.
These credits are usually purchased at a higher-than-market price. However, with the price of attending college continuing to increase, many parents find that they need to use both options of the 529 to fortify the savings account for their child. It is important to explore all of the options for your child’s future and create the best savings plan for your child.
Qualified Tuition Plans
The prepaid tuition option provides an option that allows parents to purchase college credits as a part of their child’s savings account. Also known as Qualified Tuition Plans (QTPs), they are one of the best ways to save for your child’s savings. The QTP option is guaranteed to grow at the same rate as college tuition.
This option is appealing due to the growing rates of college tuition; it allows parents to have confidence that their savings plan for their child will cover the cost of tuition in the future.
Additionally, some colleges are now able to offer what is known as the independent 529 plan. These plans are state-specific, and residency in the state at the time the account is established is often a requirement.
Parents or custodians have two options when purchasing prepaid tuition plans: one is buying units that equate to a percentage of the overall tuition (often the percentage is straightforward, with 1 unit equaling to 1% of the overall tuition).
These can all be purchased at one time or over a span of years. It is important to note that the price of the units will increase annually as the cost of tuition increases, which may have an impact on your child’s savings.
The second option is to enter into a contract to purchase tuition by the number of years. These plans can vary based on the age of the child, and parents who start their child’s savings account tend to benefit from lower payment amounts.
Coverdell Education Savings Account
A Coverdell ESA, much like the 529, is one of the better options for a child’s saving plan. It offers tax incentives that let you create a savings plan for your child that will pay for qualified education expenses.
Some of the limitations that could impact your child’s savings include a lower annual contribution allowance, $2000 per beneficiary until the age of 18, and modifications to the amounts you can contribute based on your modified adjusted gross income (MAGI). Single contributors must have a MAGI below $95,000 a year, and joint contributors must have a MAGI that is less than $190,000 to make the full contribution.
In addition, there are some limits when it comes to age and contributions that may affect the goals of your child’s savings plan. You cannot start a Coverdell ESA for any beneficiary over the age of 18, and you cannot continue to contribute after the beneficiary turns 18.
In addition, the benefits of a Coverdell ESA extend to elementary and secondary education expenses and not just to higher education. These options will allow you to integrate a Coverdell ESA into your child’s savings plans for his/her entire education.
This plan is designed to cover only qualified education expenses, which include enrollment and attendance of the minor at an approved educational institution. If the expenses are used for postsecondary education, the following expenses include fees and tuition, books, supplies, and other equipment required by the institution. This can include computers and Internet access.
If your child will need room and board, he/she must be enrolled in the institution at least part-time. This allowance for room and board, as determined by the school, was included in the attendance qualification. These are all things you should take into consideration when looking at options for your child’s savings plan.
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Another option that is available is a traditional broker-managed investment account. While an underage child cannot open his/her own brokerage account, you can open a guardian account for your child’s savings plan.
The account would be in the parent’s or custodian’s name, and all taxes and fees would be the responsibility of the parent. Your child’s savings account would be controlled by you, and you would make all the decisions regarding investments and disbursement of the funds.
Another option is to establish a custodial account. This account would make the child the owner of the assets but allow the parent to control the investment choices and manage withdrawals from the account.
The biggest thing to take into account with a custodial account is that the child is the taxable party. This means that the child bears the capital gain and tax liabilities – not the parent or custodian.
Depending on your financial situation, a custodial account could be a tax advantage as the child would most likely have a very small tax burden based on his/her lack of annual income.
This would also be the riskiest option for your child’s savings. It can offer higher returns and have fewer limitations. However, it is not without risk and, depending on your tax situation, could result in paying taxes that may impact the growth of your child’s savings account.
All investments carry some risks, but if you are looking for higher returns and more flexibility, an investment account might be a good fit with your savings plan for your child.
Last but not least, there is the trusted savings account. If you want to have your child’s savings managed by your little one, this is the best option. It can instill discipline and an understanding of how money works with your child.
This type of child’s savings plan won’t see a huge return financially, but it can go a long way to educate your child about the importance of saving and managing his/her own finances.
Starting your child’s financial education early helps him/her realize how important a savings plan is and will help your child plan well for his/her future, possibly making this option the best child’s savings plan after all.
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