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Savings for Kids: What Are Your Options?

Gregory Tanzer, Senior Managing Director, First Republic Bank
March 11, 2022

  • Adults looking to help children save for the future have several options, including kids' saving accounts and custodial accounts.
  • Savings vehicles like 529 education plans, traditional 401k(s) and Roth IRAs (individual retirement accounts) can help a child meet specific financial goals. 
  • Additional options, such as trust funds, offer unique advantages, such as allowing parents or other grantors to maintain control over their finances while still providing for the next generation. Trusts can also offer estate planning and tax benefits.

When it comes to saving, the earlier the better. Savings accounts aren’t just for adults, they can also be a helpful tool for children. Opening a savings account for a child at any age — even for a baby — helps parents and grandparents start working on a generous nest egg for the child’s future.

Showing children how to save and how important it is to save also serves as a tool to pass on positive financial habits to the next generation, so they can start to develop early money management skills by the time they’re ready for a checking account. 

If you’re an experienced saver, you likely already understand many of the savings options available to you, such as money market accounts and certificates of deposit. But you may be less familiar with the savings options available to children and the potential pros and cons of each. 

Children’s savings account 

A child savings account is a basic option that works similarly to a savings account for adults, offering many of the same benefits as adult savings accounts but with a few features that make it more kid-friendly. 

Children’s savings accounts often serve as a joint account between you and a child, so you can easily transfer money into the account when you want to, and to ensure your child isn't spending money without your knowledge. Once the child turns 18, your financial institution may allow you to remove your name from the account, or otherwise help the child transition to an adult savings account. 

Pros: 

  • Ability to earn interest, according to the interest rate associated with the child’s savings account. 
  • Potential to manage the savings account in person or via mobile or online banking.
  • Children’s bank accounts often have lower (or no) fees, or lower minimum balances than adult savings accounts. 
  • Money placed in the account may be accessed before the child turns 18.
  • Kids savings accounts are FDIC-insured up to applicable limits so the child’s money is secure in the event of a bank's failure.
  • There is no principal risk like there is in the stock market. This allows you to feel comfortable that the money will be there if your child ever needs to access it.

Cons:

  • May offer lower returns than other savings vehicles, depending on the interest rate on the account. For example: Interest was lower on deposit accounts during the pandemic due to the Fed lowering rates, making them a less attractive option for savers. 
  • Child has the option to withdraw the money before age 18, which may not align with every parent's financial plan. 

Custodial account

A custodial account, sometimes called a Uniform Gift to Minors (UGM) account, can serve as a savings tool for longer-term savings. A custodial account is set up by an adult, often a parent or guardian, on behalf of a minor. 

Unlike a joint savings account, the child is the sole account holder. However, the custodian can withdraw funds from the account for expenses that benefit the child. Once the child reaches 18 years of age, they can manage the funds in the account as they see fit and can move the funds into a traditional checking or savings account.

Pros: 

  • The custodian can deposit funds into a custodial account without fear that the child will withdraw them before age 18. 
  • Flexible use of funds; custodians can use money in the account to pay for any expense that benefits the child. 
  • Money placed in a custodial account has the potential to earn interest and grow over time. 

Cons:

  • The funds placed in a custodial account count towards a child’s total assets, which may affect whether they qualify for financial aid for college. 

Custodial accounts may also be subject to stipulations in the Uniform Transfers/Gifts to Minors Act(s) (UTMA/UGMA). Consult a financial advisor for personalized advice. 

529 college savings

Part of planning for the future includes saving for college, and a 529 plan is specifically designed to help you reach your education savings goals. Financial experts often recommend parents open a 529 savings account to help fund a child’s higher education, thanks to its unique benefits for parents. 

Depositing money in a 529 savings account comes with tax advantages. Money placed in the account grows tax-free, so neither the parent nor child needs to pay income taxes on capital gains or interest earned on the account. Withdrawals may also be made tax-free if the money is used for qualified education expenses. What’s more, several states offer state tax deductions on contributions to 529 plans, though not all of them do. These accounts are also limited to a particular dollar amount per year.

Pros: 

  • A savings vehicle specifically designed for funding a child’s K-12 and post-secondary education. 
  • Can be used to fund qualified educational expenses, including tuition, textbooks, vocational schools, K-12 expenses and even some student debt.  
  • Tax advantages: The account can grow tax-free, and the account holder can make tax-free withdrawals to cover qualified education expenses.
  • Flexibility: You can change the beneficiary on the account to another family member without paying taxes. Additional family members who qualify for transfer include: Siblings, cousins, aunts/uncles, and potentially step-children, step-siblings or in-laws

Cons:

  • Withdrawals are subject to a 10% penalty, as well as income tax, if they aren’t used for qualified education expenses (this is why overfunding a 529 plan without a backup beneficiary can be detrimental).
  • Contributions to a 529 plan may be subject to gift taxes

Roth IRA

Early savings make it easier to reach any financial goal, but that’s especially true of retirement. Opening a Roth IRA (individual retirement account) may be a good option for parents wanting to save money for their child's retirement. 

A Roth IRA offers tax advantages, since the account can grow tax-free and account holders can make tax-free deductions in retirement. Starting early means the child’s savings will grow for decades prior to retirement, and even small contributions early in life can offer significant security by retirement. 

Pros: 

  • Money in the account earns interest or capital gains tax-free.
  • Withdrawals can be made tax-free and penalty-free after age 59.5.
  • Early withdrawals may be penalty-free in certain situations, such as in the case of disability.
  • Account holders can withdraw up to $10,000 penalty-free to help with the down payment for their first home. 

Cons:

  • Subject to annual contribution limits. For 2022, the annual contribution limit is $6,000 for account holders under age 50. 
  • No tax deduction in the contribution year, meaning contributions are made with after-tax dollars.

Trust fund

A trust fund can also help provide for a child’s future. Setting up a trust fund means creating an agreement between three parties: A grantor who provides the funds (you), a trustee who manages the funds and a beneficiary (the child) who receives the funds. Money placed in a trust fund cannot be accessed until the child turns 18, or a specified age dictated by the trust.

Because a trust fund involves a third party — the trustee — it differs from a standard joint account or other savings vehicle that allows you to manage the funds directly. However, the grantor can set terms for how the assets in the trust should be managed, as well as choose a trustee who will manage the money fairly. 

Pros: 

  • Protection against overspending. Families may use a trust fund to hold all or part of a child’s inheritance, which allows the trustee to oversee how it is spent until the child reaches a certain age dictated by the trust document. Sometimes the assets are held in trust for the beneficiary's entire life. 
  • Flexibility: Assets in a trust can include cash, stocks and bonds, life insurance benefits, real estate and other assets. 
  • Allows grantors to maintain control of their finances via the trustee, even if they pass away. 
  • May reduce tax obligations for heirs, depending on your unique situation. Consult a tax advisor for advice. 
  • The grantor can decide to set the trust up in a way that allows the trust to pay the taxes on capital gains, interest and dividends, or the grantor can pay the taxes themselves.

Cons:

  • Can be complex and expensive to set up, requiring help from financial professionals. 
  • Interest or capital gains accumulated in the trust are taxable and may require insight from a tax professional to ensure you’re meeting your tax obligations. 
  • If a trustee is family or a friend of the family, decision making can become difficult when the child wishes to receive funds. Hiring a corporate trustee could alleviate this issue.

How to choose the right option for your child 

The decisions around how best to save for your child’s future are personal ones, and there’s no single “correct” way to save. However, consider the following factors when making your decisions: 

  1. Consider the financial priorities of the child: If you’re creating a financial plan for an older child, invite them to take an active role in the process. A child with their sights set on higher education may wish to prioritize contributions to a 529 plan, for example, while a child just starting to manage their money may benefit from a child savings account. 
  2. Understand the pros and cons of each option: Each savings vehicle has its own unique advantages, and truly understanding your options helps you make a more informed decision. 
  3. Start smaller, then grow: Planning for a child’s future may feel overwhelming. Choose an option that feels most manageable today, and your savings strategy can grow along with you. 
  4. Seek advice from a financial professional: An expert can help you weigh the pros and cons, offer suggestions to help you reach your financial goals and make you aware of any additional considerations. 
  5. Consider how responsible your child seems to be with their finances: This is easier to predict with older children. Allowing a child easy access to money when they don’t seem to grasp the importance of saving, or might not make responsible financial decisions, may not be your best option. 

Once you have decided, be aware you may need to take additional steps to open the account(s) you need. Different accounts — and different financial institutions — may have their own requirements, including minimum age requirements, the need for a parent to be on the account or documentation required. Consult your financial institution for more details.

The strategies mentioned in this article may have tax and legal consequences; therefore, you should consult your own attorneys and/or tax advisors to understand the tax and legal consequences of any strategies mentioned in this document. This information is governed by our Terms and Conditions of Use