The start of a new year is the perfect time to review and update your family’s financial goals, including your plans for saving for your child’s future. Starting to save money early in your child’s life means the investments have more time to grow before he reaches adulthood, but it is never too late to get started.
Review your family’s financial plan
There are financial essentials you should address first. Once they are in place, you can then decide how much of your monthly household budget to contribute to your child’s savings.
- Build an emergency fund for your household that is large enough to cover six to nine months of living expenses.
- Review the monthly contributions to your retirement savings plan. Saving enough funds to cover your living expenses when you retire takes priority over saving for your child’s college expenses.
- Put resources into place that will keep your kids financially secure, even if you pass away before they reach adulthood. Many employers offer inexpensive term life insurance policies as part of a benefits package. Review each of your life insurance policies and savings plans to ensure the list of beneficiaries is up to date.
- When listing a minor child as the beneficiary of an asset, designate an adult to serve as the custodian of the asset until your child reaches adulthood. As a safety measure, also list this adult as a property guardian in your will.
Select accounts to hold the savings
Once you determine how much to contribute each month toward your child’s savings, you are ready to select where to place the funds.
Traditional savings
Pros: A traditional savings account is a low-risk place to keep funds, and it is easy to withdraw funds when you need to. It is also an opportunity to teach your child crucial financial skills. Your child can deposit a portion of his weekly allowance in his account and watch his savings grow.
Cons: The interest rate on a traditional savings account is rather low.
Roth IRA account
Pros: There are a variety of investments to choose from, and the earnings grow tax-free. You can withdraw funds from the plan to pay for your child’s educational expenses without paying early withdrawal penalties. As the owner of a ROTH IRA, you retain complete control over the account.
Cons: The maximum combined amount you can contribute yearly to your Roth IRAs is $6,000 (plus $1,000 if you are over 50). If you do withdraw earnings to pay educational expenses before reaching age 59 ½, you will owe income tax on the withdrawal.
UGMA & UTMA Accounts
(Uniform Gift to Minors Act and Uniform Transfer to Minors Act)
Pros: A variety of assets can be placed in UGMA/UTMA accounts, giving you some flexibility when deciding what types of investments to transfer to your child.
Cons: Once you transfer assets to your child’s account, the assets belong to your child, and you cannot take back ownership. Also, once your child reaches the legal age to take control of the account, your oversight ends, and he can use the funds as he wishes.
529 plan
Pros: The earnings from the investments in a 529 plan grow tax-free. You do not have to pay federal income tax on funds withdrawn from a 529 plan to pay qualified educational expenses. Your child (the beneficiary) has no control over the account, and you can change the beneficiary to another family member if needed.
Cons: There are a limited number of investments, and the funds can only be used to pay qualified educational expenses.
Resources:
Roth IRA: https://www.irs.gov/retirement-plans/roth-iras
Georgia 529 plan: https://www.path2college529.com/
Alabama 528 plan: https://www.collegecounts529.com/
UTMA/UGMA Custodial accounts: https://www.thebalance.com/beginners-guide-to-ugma-and-utma-custodial-accounts-4060475
