6 Ways to Save and Invest Money for Kids

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I got an email from Heather que who says I love the money girl podcast. I just opened a 12 month CD for my daughter and planned to give her the money when she’s an adult.

But I have about eight more years to save for her. Should I open new CDs as I save more? Or should I just add money to the same CD once it matures? Thanks so much for your question, Heather, I know your daughter will be thrilled to have a financial leg up as she launches and becomes independent. If you also have children or are thinking about starting a family, it’s essential to get familiar with strategies and accounts that make it a little easier to save and invest for your kids. So if that’s you, I hope you’ll stick with me. Hey everyone. And thanks for joining me this week. My name is Laura Adams. I’m a personal finance and small business expert, author and educator. Who’s been writing and hosting money girl since 2008. My mission is to help you get the knowledge and motivation to prioritize your finances, build wealth and have more security and less stress.

If you’re a new listener, I am so glad that you found the show and hope you’ll stick around by subscribing. And I also want to mention that we always publish the show notes. They’re over in the money girl [email protected]. If you want to look for this show, it’s episode number 680, called six ways to save and invest money for kids. I’ll answer Heather’s question by reviewing six savings options you have for kids and the pros and cons for each one. Plus I’ll discuss when to begin saving for a child’s future and how it should fit into your big financial picture. So let’s start out by talking about when you should begin saving being a parent means you got plenty of expenses and maybe a lot of ongoing financial stress. You definitely want the best for your children, but you also need to make wise decisions for your own future.

While the cost of college seems to rise faster than hot air we’re living longer, and we may have less social security, retirement income to count on in the future. That means you likely need a bigger nest egg than you may think. My point is that you should never forego saving for your own retirement to pay for a kid’s college or any other significant expenses that come with having kids instead create a financial plan that includes your retirement and savings for kids. As soon as you start a family, the sooner you begin saving for short and long-term goals, the less stress you’ll feel in your budget. And also the less stress you’ll feel emotionally. If you get a late start saving and you just can’t afford to pay for a child’s education or a car or any other big expense that they may want, don’t feel guilty about it.

Remember putting retirement first is in your entire family’s best interest. If you sacrifice your financial security for your kids, you may find yourself relying on them to support you in your old age, while it might seem cold-hearted for a parent to refuse to pay for a child’s education or any other major expenses. Don’t forget that kids have options. And especially when it comes to paying for college, like working, getting scholarships and taking out federal student loans. Remember there are no loans or grants or scholarships to support you after you stopped working in retirement. If you’re less than 20 years from retirement right now, and you have not reached at least 80% of your savings goal, I want you to stay exclusively focused on building your retirement nest egg, again, shore up your financial wellbeing first, even if that means saving nothing or less than you’d like for your kids, ideally you should regularly save at least 10 to 15% of your gross income for retirement before saving for your kids.

You might end up with a surplus of retirement savings. And in that case, you could always help a child by paying off their student loans or any other debt they may have down the road. So when the time is right to save and invest money for your kids, I’m going to go through six great options. And the first is to use a bank savings account and MDIC insured bank savings account is definitely one of the safest places to squirrel away money for a child’s future. The problem is, as you probably know, it doesn’t come with many benefits. Our regular savings account pays very low interest. And what you earn also gets taxed as income. If you have a large amount to save, consider getting a high yield savings account, which pays a double or triple in some cases compared to regular savings. However, what you earn is still relatively low compared to other options that we’re going to cover in the show.

Let me give you an example. Let’s say you say a hundred dollars a month for a child over 20 years in a bank account, earning 0.2, 5% interest. You would accumulate less than $25,000, but if you put the same amount of money each month in a high yield savings, that’s earning 2%. You’d have almost $30,000 after two decades. Now, if you’re like Heather, you might consider opening a CD with a bank or other financial institution for even higher returns. CDs can be FDI insured, and they’re also extremely safe with a CD you loan money to the institution, which then lends that money to their customers. And in return for that, you receive a set rate for a period, which is called the term and CD terms can range from a few months to a few years in general, the longer the term, the more interest you receive.

And when the term is up, you receive your initial deposit. Plus any interest accrued. Heather wants to know if she should add money to her 12 month CD. When the term is up, which is known as the maturity date, or get a new CD. Heather in general, traditional CDs do not allow you to add money after your initial deposit. So you’re going to need to open a new CD. However, I will say there are many different types of CDs and one is called an add on CD, which does allow you to make a set number of deposits during the certificates term. So Heather, if you, by any chance, do have an add on CD. You could make multiple deposits before it matures, but I would probably guess that you don’t. So again, you would need to open a new CD once that the one you have matures.

So let’s talk about the pros and cons for bank savings accounts and other bank products like CDs using FBIC insured, bank savings, high yield savings, or even a CD means that it is entirely safe from investment risk, but in exchange for that safety, these types of accounts pay very little interest. So that means you could be leaving many thousands of dollars on the table compared to investing the funds. Also, you must include the accounts value in the calculation for future financial aid. If that’s something that’s on your mind, if you’re looking at saving for a child’s education, all right, let’s talk about the second type of account that you can use for a child, which is opening a five 29 college savings plan paying for college is definitely the most common reason. Parents want to sock away money for their kids in the first place.

If you or your child know that college is in the future. One of the best options is the five 29 college savings plan with a five 29. You contribute funds on any schedule you like, and you choose how to invest them from a menu of options, such as mutual funds. Then the funds can be withdrawn tax-free if you use them to pay qualified education expenses, such as tuition fees, books required, equipment and room and board funds, and a five 29 plan can be spent at us accredited schools. And even at some foreign institutions, for example, you could live in Florida, participate in a New York five 29 savings plan and use the funds to send a child to college in California. Thanks to the tax cuts and jobs act. You can spend up to $10,000 per year. Tax-free on elementary and secondary school expenses. So that gives parents the flexibility to withdraw funds for tuition and other education expenses for a younger child, attending a public private or religious school.

You can use a 529, no matter how much you earn. And the maximum annual contribution limit depends on the plan you choose, but it could be over six figures per student, in some cases, funds and a five 29 belonged to the owner and the account can have one designated beneficiary who is the future student. So if you want to save for more than one child, you generally need to open an account for each of them, but you can also change a five 29 beneficiary to another member of the family, or even roll it over to another five 29 without triggering tax consequences. States generally sponsor their own five 29 plans and many offer additional tax savings, such as a deduction on your state income taxes for your contributions, the fees and benefits like the maximum contribution limit investment options. And in-state tax benefits vary considerably from one plan to another.

So you do need to do your homework to sign up for a five 29. You can go directly to the plan manager. You can use a financial advisor, or you can start doing your homework at sites, such as saving for college.com and college savings.org. Okay, now let’s cover the pros and cons for five 29 plans due to the benefits that you get with a five 29, such as the tax advantages, flexibility and high contribution limits, it really gets my vote is the best account to save for a child’s education. Additionally, your five 29 distributions get favorable treatment because they are not considered income in the calculation for financial aid. The main drawback is that if you use a five 29 for non-qualified education expenses, you will have to pay income tax plus a 10% penalty on those withdrawals. So you never want to put more in a five 29 than you estimate your child will need for their total education expenses.

Also note that you can’t start funding a five 29 until your child is born and has a social security number. All right, moving on to the third account, you can use to save for a child, which is to enroll in a five 29 prepaid tuition plan. So this is different from the regular 529 savings plan. And it’s great if you want to save for a child’s education without taking any investment risk. So these prepaid plans allow you to save money by locking in today’s tuition costs for the future. Prepaid plans are offered by certain institutions and nine states, including Florida, Maryland, Massachusetts, Michigan, Mississippi, Nevada, Pennsylvania, Texas, and Washington. And there’s also a national private college 29 plan that you can use no matter where you live again to lock intuition at a future rate at about 300 private colleges and universities across the country.

When you open a prepaid plan, you must name your student who is the beneficiary, but you don’t have to pick a school until your student is ready to enroll. You can even change plan beneficiaries. If you have another potential student in the family, and you can even have a five 29 pre-paid plan and a five 29 college savings plan for the same student, your prepaid account would pay tuition. And your savings plan could be for other qualified expenses, such as room and board books, supplies, and computer equipment. Okay. Now let’s cover the pros and cons for the five 29 prepaid plan. The prepaid plan does not require you to choose investments or be subject to market volatility. Also, it’s not a factor in the calculation for financial aid eligibility, but the major downside to a prepaid plan is that if the beneficiary wants to attend a school that accepts a portion or none of the funds, you will have to pay the tuition difference out of pocket. In other words, there’s a risk that you might not get the total value of the plan, depending on where your child ends up going to school, like with a five 29 savings plan, you must pay income tax, plus a 10% penalty on any funds that you spend on non-qualified expenses. And you do have to wait until your child is born and has a social security number to set them up as a prepaid plan beneficiary.

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All right, let’s move on to the fourth account, which is a U G M a or UTMA account. And this stands for uniform gift to minors act or uniform transfer to minors act. These accounts are great. If you want to save money for a child for non-education expenses. In most states, minors cannot own investments and financial products in their names because they’re minors. So that means that parents can’t just give investments or transfer assets to a minor child without first creating a trust. And the most common trust for minors is a custodial account known as a G M a again, uniform gift to minors act, or it might be depending on where you live. U T M a the uniform transfer to minors act. These allow investments for minors, such as mutual funds and real estate to be held in the care of an account custodian.

And you can set up one of these custodial accounts at most banks and brokerage firms like fidelity or Vanguard. Then you can make withdrawals to cover expenses that benefit the child. And when the child becomes an adult, usually at age 18 or 21, depending on where you live, the trust assets automatically transfer into the child’s name, all right, pros and cons for these accounts, the main benefit of using a [inaudible] or UTMA account is that you can give a child as much money or assets as you like. There are no annual limits, and you can also withdraw funds at any time. For any reason, a portion of the accounts investment earnings does get taxed at your child’s income tax rate, which can reduce taxes. Now, the downside of these custodial accounts is that once the child reaches the age of majority, parents have no control over how the child spends the funds.

Also custodial accounts are considered an asset of the child, which means they’re a more significant factor in the calculation for financial aid. Then if the funds were owned by a parent, all right, the fifth account you can use to save for a child is a life insurance policy, and often overlooked way to protect a child’s financial future is to purchase life insurance. This is a contract that pays one or more beneficiaries after the policy holder dies. And there are two main types of life coverage. You’ve got term, and you’ve got permanent policies. A term policy pays a cash benefit. If you die within a specific term, such as 10 or 20 years, and a permanent policy would cover you no matter when you die. And it may also accumulate a cash value, you can tap the accumulated value or allow it to grow for a child.

If you’re relatively young and healthy, a half a million dollar 20 year term life policy may only cost less than $20 a month. So it costs much less than you might expect. And it’s wise to cover both parents, especially if one is an at-home caretaker. Remember that if a stay-at-home parent dies, the cost to replace them would be significant. If you get life insurance through work, it may not be enough. You want to review what you’re getting. Most companies offer coverage in an amount equal to one or two times your annual salary. So depending on your financial needs and your family size, having life coverage in an amount equal to 10 times, your income is a much better rule of thumb. Also remember that if you leave your job or you get terminated, your life ends since you can have multiple life insurance policies, it’s smart to always maintain your own coverage.

In addition to any policy that you may get through work, you can get free [email protected]. All right, here are the pros and cons for life insurance. I think every parent should have life insurance. So their child would be financially secure after their death. The beneficiary would receive a lump sum payment from a term policy, or get an amount plus additional cash value with a permanent policy. Now, the downside of life insurance is that it typically does not provide a benefit until the policy holder dies. So that may not be beneficial to the child unless you die. However, if you have a permanent policy that builds cash value over time, you could tap it to pay expenses for a child such as education or a vehicle. All right, the sixth account that you can use to save for a child is a Roth IRA. A Roth IRA or individual retirement account is one option to help an older child save money.

Unlike other retirement accounts, you can spend the original contributions, but not the earnings in a Roth IRA before retirement, without having to pay taxes or that 10% early withdrawal penalty contributions to a Roth IRA are not tax deductible. You can only add money on an after tax basis up to an annual limit. You choose how to invest the balance. Using a menu of options, such as mutual funds. Many people don’t realize that kids can have an IRA, even minors. If they have earned income from a part-time job or self-employment income as a parent, you can make an IRA contribution on your child’s behalf for as much money as they earn up to the annual limit, which is currently $6,000, but you can’t fund an IRA for an infant or a toddler who can’t legitimately earn income. So it’s generally just an option for teenage kids to save and invest when they’re earning their own money.

However, if you have a young or non-working child, another option is to fund your own Roth IRA. So your own Roth as a parent, and then take withdrawals to pay expenses for your child. There is an annual income limit to qualify for a Roth IRA. So if you’re a high earner, you may not be eligible to make contributions. It’s really easy to open a Roth IRA for yourself or a minor at most major banks, brokerages and investment companies, such as USA and betterment.com. Now the pros and cons for a Roth IRA or Roth, IRA offers flexible withdrawals of original contributions that you can spend on college or any expenses that you like. Unlike a five 29 savings plan. If you don’t need some or all of the money for college, you can just leave it in the account. And the balance is not counted in the calculation for financial aid.

However, if you withdraw the earnings portion of a Roth IRA before reaching age 59 and a half, you typically must pay income tax and penalties, unless you qualify for an exemption. Also withdrawals do not count as income for financial aid eligibility. All right, I know we covered a lot here, but these are some great ways that you can help a child get a leg up for their financial future. I’d love to know what questions you have about saving for a child or for your own future. You can leave me a voicemail by calling (302) 364-0308. And you can also send me an email just like Heather did by using my [email protected]. And thanks again to Heather for your great question. And while you’re at Laura D adams.com consider signing up for my weekly or biweekly newsletter. It’s a short update from me. That’s filled with tips and tools that I think you’ll enjoy.

It’ll help you save more, grow your money and become an amazing money manager. You can get on the [email protected] or by sending me a quick text message, just text the phrase, get updates with no space to the number three, three, four, four, four. And if you’re not into email, another great way to stay in touch is to join my private Facebook group called dominate your dollars. Just search for it on Facebook or text the word dollars. D O L L a R S to the number three, three, four, four, four. I hope to see you in the group. That’s all for now. I’ll talk to you next week until then here’s to living a richer life. Money girl is produced by the audio wizard, Steve Ricky Berg with editorial support from Karen Hertzberg. If you’ve been enjoying the podcast, take a moment to rate and review it on apple podcasts. New episodes are released every Wednesday and when you’re subscribed, you automatically get them for free. Be sure to hit the subscribe button in the apple podcast app or wherever you listen. You might also like the backlist episodes and the show notes that are always [email protected].