Starting a family almost always means parents will need to make adjustments to their finances. From buying birthday presents to paying fees for extracurricular activities, raising kids can be costly.
“If you look at the cost of college, that number is pretty staggering,” says Kara Duckworth, certified financial planner and managing director of client experience for Mercer Advisors in Newport Beach, California.
However, college is only one cost incurred by parents. There may also be medical bills, summer camp fees and wedding expenses once that child becomes an adult. Whether you want to teach your child smart money-management strategies, help them pay for college or set them up for financial success as adults, it’s important to jump-start savings for kids early on.
“Always begin with the end in mind,” says Alex Klingelhoeffer, certified financial planner and wealth advisor with Exencial Wealth Advisors in Oklahoma City. The best way to save money for kids will depend on your goals.
[READ: Ways to Teach Kids About Money.]
Here are eight options to consider:
— Create a children’s savings account.
— Leverage a 529 college savings or prepaid tuition plan.
— Use a Roth IRA.
— Open a health savings account.
— Look into an ABLE account.
— Open a custodial account.
— Set aside money in a trust fund.
— Use tools that teach the value of saving money.
1. Create a Children’s Savings Account
Most banks and credit unions offer children’s savings accounts, which parents can co-own. These accounts can help children develop the habit of saving, rather than spending, their money.
“What a lot of people do is open a separate savings account,” says Trevor Stone, certified financial planner and senior advisor with the Compardo, Wienstroer, Conrad and Janes office of advisory firm Moneta in St. Louis. According to Stone, it’s the most basic way to save for kids.
Rather than paying a cash allowance, parents may want to set up recurring allowance transfers to their child’s savings account. This can encourage children to take an active role in managing their money while earning some interest as well.
As children age, they may be moved into teen checking accounts and issued debit cards. Parents remain co-owners of teen accounts to oversee and assist their children with money management as needed.
2. Leverage a 529 College Savings or Prepaid Tuition Plan
Financial experts seem to universally agree that a 529 plan is the best way to save money for child college costs. The accounts come with tax benefits, and many plans feature low fees.
There are two types of 529 plans. One is a general college savings plan that allows parents to put money aside into an account that can be used at any qualifying college or private K-12 institution. Some states provide a tax deduction for contributions to their state’s 529 plan, and withdrawals used for qualified education expenses are exempt from federal income tax.
The other option is a prepaid tuition plan that locks in current tuition rates for public institutions. While the ability to lock in tuition rates is a valuable benefit, the college savings option offers more flexibility and may be a better choice for most families.
Either way, be sure you understand any limitations on the use of money in the account. “You can’t use a 529 plan for travel (to programs abroad) or to drive back and forth to school,” Duckworth says. Withdrawing money for nonqualified purchases could result in a tax penalty.
[READ: Ways to Save for Your Child’s College Education]
3. Use a Roth IRA
Dipping into your retirement savings for your kids may not sound like a smart plan, but it can be OK so long as it’s done with proper planning. Roth IRAs can be a smart choice if you’re looking for the best savings plan for child expenses that offers flexibility.
A Roth IRA allows people to save after-tax dollars for retirement. In 2023, workers younger than age 50 can save up to $6,500 while those age 50 and older can contribute $7,500. Money withdrawn after age 59½ is tax-free, but withdrawing any gains prior to that age results in a 10% tax penalty.
Roth IRAs offer some flexibility because the principal amount can be taken out at any time without tax or penalty. Depending on your age, you could use some or all of the money placed into a Roth IRA for your child’s college education or other expenses. However, if you plan to deplete the account, make sure you have another source of retirement savings like a 401(k).
There are income limits for those who want to contribute to a Roth IRA, but high-earning households can use a backdoor Roth IRA strategy to access these accounts. In 2023, the ability to contribute to a Roth IRA begins to phase out for married couples filing jointly at incomes of $218,000. To get around this limit, they can make a nondeductible contribution to a traditional IRA and then convert to a Roth IRA.
Don’t overlook the fact that teens can also open their own Roth IRA once they have a job and begin earning money. “That’s something people don’t really think about,” Duckworth says. Some of her clients match their children’s IRA contributions to provide an additional incentive for them to save.
4. Open a Health Savings Account
If you are covered by a high-deductible health insurance plan, a health savings account is another option to consider. “These are generally the best accounts for health care,” Stone says.
Those with a qualified high-deductible family health insurance plan can contribute up to $7,750 in 2023 to a health savings account. This money is tax-deductible, grows tax-free and can be withdrawn tax-free for qualified medical expenses for yourself and your child. At age 65, money can be withdrawn for any reason and will only be subject to regular income tax, the same as a traditional 401(k) or IRA.
While a married couple can only open one health savings account, each adult child covered by a family plan can open their own account and anyone can make contributions totaling up to $7,750. There are limitations to the use of this money, but having an account dedicated to health care costs can help smooth your child’s transition into adulthood.
Those who aren’t eligible to open an HSA can see if their employer offers a flexible spending account for health care expenses. These accounts offer similar tax benefits, but contribution limits are lower. Keep in mind that while the balance in an HSA rolls over year after year and can be invested, cash in an FSA generally must be spent within a designated period or be forfeited.
5. Look Into an ABLE Account
Parents who have a child with a disability may want to open an ABLE account. These accounts are relatively new — created by 2014 legislation — and allow up to $17,000 in contributions in 2023. While there is no federal tax deduction for contributions, money in the account grows tax-free and can be withdrawn tax-free for qualified expenses.
However, that’s not the account’s biggest benefit.
“The great thing about the ABLE accounts is that they don’t count against government assistance,” Duckworth says. That means parents can save for their children without inadvertently jeopardizing their eligibility for food assistance, Medicaid or other service programs.
Only those who develop a disability prior to age 26 are eligible for an ABLE account. If parents have a 529 plan for their child, they can roll money over from that account to the ABLE account, up to the annual contribution limit.
6. Open a Custodial Account
A custodial account may be best for those who want to save money for their children but don’t want them to have access to the cash until they are adults. The money is held in the child’s name, but parents can deposit money and manage the account until the child reaches the age of majority.
Custodial accounts may be set up at banks such as Bank of America or brokerage firms like Charles Schwab and Franklin Templeton. They are governed by the Uniform Gifts to Minors Act and the Uniform Transfers to Minors Act. The accounts allow children to own securities or other assets that may otherwise be off-limits for them.
While custodial accounts don’t provide the same tax benefits as other college savings vehicles, they may be a good choice for parents who aren’t sure their child will go to college or who want to provide a financial gift upon adulthood. Once a child reaches the age of majority as governed by their state, money from a custodial account is transferred to him or her.
That automatic transfer could be a drawback in some situations, according to Klingelhoeffer. A parent may have saved money with the intention that it be used for a specific purpose, such as buying a house, but there is nothing stopping an adult child from using the money for other purposes.
If the account is opened when a child is very young, Klingelhoeffer says, “you don’t have a lot of foresight into whether that child is going to be responsible.”
7. Set Aside Money in a Trust Fund
To sidestep the shortcomings of custodial accounts, parents might want to use a trust instead. “Trust accounts can be very flexible in how you draft them,” Stone says, and limits can be placed on how the money is used and when it is accessed.
“Money is an amplifier,” Klingelhoeffer says. In the right hands, it can be used for good, but there is also the potential that it will compound problems for a child who uses it irresponsibly or spends it on bad habits. “What we don’t want to do is have money be destructive to people,” he says.
A trust fund can address that concern. It can be set up with any amount of money, but it usually doesn’t make sense unless you have a large amount of cash to deposit into it. An attorney needs to draw up the trust documents, and someone must be appointed to manage the money. Expect to spend at least several thousand dollars to create one.
Still, for wealthy families, a trust fund offers more control over disbursements, protects cash from creditors and ensures a child’s assets aren’t split during a divorce.
[Read: Estate Planning Tips to Keep Your Money in the Family.]
8. Use Tools That Teach the Value of Saving Money
Creating savings for kids is important, but parents shouldn’t overlook the value of teaching children to set aside money for themselves. Stone advises parents to review bank statements with their children, talk about why they are saving and look for hands-on tools that can be more effective than simply talking to kids about money.
One way to teach more advanced concepts such as investing is to give children a say in stock purchases. Some investment firms, such as Schwab, allow the sale of fractional shares which makes it possible for even those with limited money to own a part of popular companies like Disney and Apple.
Meanwhile, the Stockpile app issues gift cards that kids can redeem for stock in their favorite company. Custodial accounts on the app allow kids to have their own login to manage their account and request stock trades, which their parents then approve. Then, over time, children can see how the value of the money they save and invest changes.
Parents should also make a point to include children in money discussions when appropriate. These may include, for instance, discussing the cost of household expenses or planning to save for a vacation. Finances can be a taboo topic in some households, but it’s important for kids to see and hear these discussions to help them make smart money decisions when they get older.
More from U.S. News
What to Do if You Fall Behind on Bills
How to Save Money for Your Kids originally appeared on usnews.com
Update 08/24/23: This story was published at an earlier date and has been updated with new information.
