Want to give kids a financial head start? There are many good financial vehicles parents can use to save and invest money for a child’s future. Laura reviews the pros and cons of six of the best savings options so you know which one is right for your family.
There’s no doubt that raising kids is expensive. According to a 2017 report from the U.S. Department of Agriculture, the average cost for a child through age 17 is about $235,000. That doesn’t even include the cost of college!
Fortunately, there are many good financial vehicles that help parents save and invest money for a child’s future. There’s no one account that makes sense for every family, but I’ll review the pros and cons of six of the best savings options so you know which one is right for you.
6 Ways to Save and Invest Money for Kids
- 529 college savings plan
- 529 prepaid tuition plan
- Roth IRA
- UGMA/UTMA account
- Brokerage account
- Savings account
Here’s more detail about different ways to save money for kids.
1. 529 college savings plan
Paying for college is the most common reason that parents want to save money for their kids. If you or your child know that college is in the future, one of the best options is a 529 college savings plan.
With a 529 plan, you make contributions and invest them in a menu of options, such as mutual funds. Your money can be withdrawn tax-free when it’s used for education expenses, such as tuition, fees, books, required equipment, and room and board.
Funds in a 529 plan can be used at any accredited school in the country, and even at some foreign institutions.
Funds in a 529 plan can be used at any accredited school in the country, and even at some foreign institutions. For instance, you could live in New York, participate in a Florida 529 saving plan, and use the money to pay for a school in California.
Plus, starting in 2018, you can spend up to $10,000 per year tax-free on elementary and secondary school expenses, according to the Tax Cuts and Jobs Act. That gives parents the flexibility to make withdrawals for tuition and other educational expenses for a younger child who attends a public, private, or religious school.
Everyone can use a 529 savings plan because there’s no restriction on annual income. The maximum amount you can contribute each year varies on the plan you choose, but could be over six figures per student!
The funds in a 529 plan belong 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 must open an account for each of them. But you can also change a 529 beneficiary to another member of the family or roll it over to another 529 plan without triggering tax consequences.
States generally sponsor their own 529 plans and many offer additional tax savings, such as a deduction on your state income taxes for contributions. The fees and benefits—such the maximum contribution limit, investment options, and in-state tax benefits—vary. So, it’s important to do your homework and compare plans across the country using sites like Collegesavings.org and Savingforcollege.com.
To sign up for a 529 you can go directly to the plan manager or use a financial advisor. No matter if you contribute $10 a month or $1,000 a month to a 529 plan, the sooner you get started, the easier it will be for you and your family to pay for college.
Pro: Due to all the benefits that come with a 529 plan, such as tax advantages, flexibility, and high contribution limits, it gets my vote for the best account to save for education costs. Additionally, distributions get favorable treatment because they're not factored as income in the calculation for the following year's financial aid eligibility.
Con: The main drawback is that using 529 funds for anything other than qualified education expenses, triggers income tax, plus a 10% penalty. So never contribute more to a 529 than you believe your child will need for the total of his or her education expenses. Also, you can’t begin investing until your child is born and has a Social Security number.
2. 529 prepaid tuition plan
If you like the idea of setting aside money for a child’s education, but don’t want any investment risk, check out a 529 prepaid tuition plan. They’re offered by states or institutions, but aren’t available in every state. The idea is that college costs rise year after year, so locking in future tuition at today’s rate can save money.
Funds in a prepaid plan may be withdrawn so you can use them at an out-of-state school or at a private college.
But what if your child wants to go to a different school? Funds in a prepaid plan may be withdrawn so you can use them at an out-of-state school or at a private college. You can also change plan beneficiaries at any time if you have another potential student in the family.
You can even have both a 529 prepaid plan and a 529 college savings plan for the same beneficiary. The prepaid account would pay for tuition and the savings plan could be for other expenses, such as room and board, books, supplies, and computer equipment.
Pro: A 529 prepaid tuition plan doesn’t require you to choose investments or deal with any stock market volatility. Also, it’s not a factor in the calculation for the following year's financial aid eligibility.
Con: The major downside to a 529 prepaid plan is that if the beneficiary chooses an out-of-state school, you must pay the tuition difference out of pocket, and may not get the full value of the plan. Just like with a 529 savings plan, you must pay income tax plus a 10% penalty on funds spent on non-qualified expenses. And you must wait until your child is born and has a Social Security number to set him or her up as a plan beneficiary.
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