It doesn't take much money to give your child a financial head start. Thanks to the power of compound interest, investing just $1 a day from birth could be worth $13,000 by the time they turn 18. And if they then let that balance keep growing until retirement, even without contributing further, they could end up with more than $400,000.
"Your greatest asset is time," points out Mark Kantrowitz, publisher and vice president of research at SavingforCollege.com.
Using the right account to grow that money can help. Depending on your family's goals and needs, there are a number of different accounts and assets that parents, family members, and other well-wishers might use to save on a child's behalf.
"There isn't one that's the best, per se, for everything," says T. Eric Reich, a certified financial planner and president of Reich Asset Management in Marmora, N.J. "The impetus behind the decision has to be your intent." In other words, figuring out what you or your child will want this money for can help you pick the best options.
Families looking to save on behalf of a child have lots of options, from basics like savings accounts and savings bonds to more complicated strategies involving life insurance policies and trusts. For a child with a disability, there are also special needs trusts and ABLE accounts.
When it comes to big, long-term goals like saving for your kid's college, early adulthood, or their retirement, here are three common options.
When it comes to saving for college, "the 529 plan has become the primary vehicle of choice," Justin Halverson, a financial advisor at Minnesota-based Great Waters Financial, recently told Grow. These state-based, tax-advantaged accounts are designed with education expenses in mind.
There's no annual limit per account, and each donor can contribute up to $15,000 per year per child free of gift-tax consequences. You can also front-load up to five years' worth of contributions while avoiding the gift tax. Limits on the total balance vary by state and range from $235,000 to $529,000, according to SavingforCollege.com.
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Consumers can set up Uniform Gifts/Transfers to Minors Act (UGMA/UTMA) accounts through a brokerage firm or other financial institution. These more general investment accounts are named after a set of laws that let adults transfer assets to minors without setting up a special trust.
There's no annual limit per account, and each donor can contribute up to $15,000 per year per child free of gift-tax consequences.
"If you're younger and in a lower tax bracket, you should shovel everything you can into a Roth account," Ed Slott, a certified public accountant and founder of Ed Slott & Co., recently told Grow.
You can open a custodial version of this tax-advantaged retirement account on behalf of a minor as soon as they start working, with total contributions for 2020 limited to their earned income or $6,000, whichever is less.
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Which account or accounts are the best fit depends on factors like the goal, how much you earn, and how much you (and others) want to contribute each year.
It may help to talk through your options with a financial advisor, who can help navigate complexities like potential gift tax consequences on contributions and the right custodian to choose for an account. SavingforCollege.com also has a tool to help you compare based on priorities like maximizing federal student aid or minimizing taxes.
"Key questions are going to be the tax impact, the return on investments, and the impact on financial aid eligibility if the child does go to college," Kantrowitz says.
The formula for the Free Application for Federal Student Aid, or FAFSA, is more favorable toward assets in a parent's name (like a 529) than those in the child's name (like a UGMA or UTMA), while balances in retirement accounts for either party aren't factored in at all. If you'd saved up $10,000, having it in an UGMA/UTMA could reduce your aid eligibility by up to 20%, or $2,000, he said, versus a maximum 5.64%, or $564, if you'd kept it in a 529.
If college is "a definite yes," Kantrowitz says, "a 529 plan is the most tax-advantaged and financial aid-advantaged option."
No matter which path you choose, it's smart to think ahead and invest in your child's future. "The key, really, is to think about what you're trying to accomplish," Reich says. "Do the little bit of planning upfront in terms of, 'What do I really want?'"
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