Saving For Your Kids & Grandkids
With our third baby due this spring, my husband and I have been making some changes to our budget. Additional childcare costs, diapers, medical bills, you name it; kids aren’t cheap. We’ve also spent a lot of time talking about saving for our kids’ futures. I get asked by clients about savings for their kids and grandkids all the time, so today I’m going to talk a little about the different savings options parents and grandparents have.
I am a big proponent of setting our children on the right path to a secure financial future. What I am not a proponent of is adults sacrificing their own financial security to save for their children’s future. As an adult, it is important to remember that you have a finite amount of time to save for your future retirement. Children and teens have many many years and lots of time for do-overs. My most important piece of advice when it comes to saving for children will always be to make sure you are in good financial standing prior to saving a single penny for your children. I know that sounds cold, but unless you want to live in that child’s basement… you’ll take my advice.
There are a few different strategies when it comes to savings for your kids. Each one has its pros and cons and none of them are more-right than the others. It all depends on what your family’s goals and needs are.
1. 529 College Savings Plans
When it comes to saving for higher education, the 529 plan is very popular. An example of a 529 plan would be Achieve Montana. It is a plan specifically designed to help save for the cost of higher education and gives some tax incentives along the way. Money contributed to a 529 plan is tax deductible to the contributor (with certain limitations) and can be withdrawn and used for qualified higher education costs tax-free. For those parents and grandparents starting early and with strong higher education convictions, this can be a great option. The tax-free growth over a long period of time is very advantageous. The beneficiary on the account (the child) can be changed should one child choose not to go to college or receive enough in scholarships that no other funding is necessary. If, however, the funds are distributed and used for purposes other than qualified education, the family must pay ordinary income taxes as well as a 10% penalty on the funds. If higher education isn’t the likely plan for the child or if the time horizon is very short, this plan might not be the best option.
2. Custodial Accounts
UGMA accounts (Unified Gift to Minors Act) are accounts that are held in the name of the child but are controlled by the parent or other custodian (grandparent, relative…). The custodian remains in control of the account until the child reaches the age of majority in their state. The age of majority in Montana, for example, is 18. It typically ranges anywhere from 18 to 21. At that age, the child takes control of the account and has full discretion of how they will use the funds. Prior to the age of majority, the account is still in the child’s name, but the custodian does have the authority to withdraw funds and make changes to the account, so long as it benefits the child. There are situations where a child should likely not be granted full discretion and access at the age of majority. Although the account cannot be taken away from them, there are changes that can sometimes be made such as converting the account to a 529 thus encouraging use for higher education, or drawing down funds to use to pay the child’s other expense prior to age of majority. Each state has slightly different rules and it’s important to understand those rules prior to opening a UGMA/UTMA account. There are no special tax incentives related to the custodial accounts but with that comes less restrictive withdrawal rules.
3. Kids’ Accounts
We see this one a lot when there are family members that want to save for kids but don’t want the restrictions associated with the prior two options. This is actually the option my husband and I have tentatively chosen for our children. We created an account that is in our names and reports to our social security numbers, but we titled it “Boys’ Account.” Our boys are listed as the beneficiaries on the account should anything happen to us, but currently we own the account and all the money in it. We have full discretion over how we want it invested and what we want it used for. If you’ve read my blog post on college, you know that I am skeptical about what higher education will look like in 13 years when we are looking at sending our kids. My kids may choose a trade instead. This way, we have full flexibility in choosing how we want to help our children with that money. It may be used for a down payment on a house someday or to pay for a wedding. Now, all that being said, we bare the burden of all the taxes due on the account and there are no tax breaks for contributions or on withdrawals. We have a few clients who have “Grandma Grandpa Accounts.” That’s how they are titled when we pull up their portfolio and we know that the intention is for that money to be used for the grandkids at grandma and grandpa’s discretion. In these situations, we kept the grandparents in full control and ownership of the assets in case they would be to need them for their own unforeseen retirement expenses.
4. Minor Roths
A Roth IRA is a type of retirement account that allows for after-tax contributions and tax-free growth and withdrawals. Typically, these accounts are set up with a longer time horizon in mind than higher education or wedding funds. These are often for retirement money because withdrawals prior to age 59 ½ (with the exception of return of contributions) are both taxed as income and penalized 10%. Now, there are penalty exceptions for qualified education expenses, qualified first-time home buyers and a few other situations, but all-in-all, they are most often used for retirement. In order for a minor to have a Roth IRA, they must have earned income. We commonly see these accounts opened for teenagers who have part-time jobs but aren’t old enough to open an account on their own. The account is opened in the child’s name and with their social security number, but there is a custodian on the account (typically a parent) that controls how the funds are invested and used prior to the child turning 18. There are contribution limits and income bounds on Roth accounts.
These are the four most common savings tools that we use for our clients who are saving for a child. They all have their purpose and they all have their pros and cons. The best option for your family might not be what’s best for someone else. It’s all about your family’s goals. If you’re looking into doing some savings for your kids’ futures, I strongly recommend talking to your financial advisor and learning the ins and outs of each option and the different rules relating specifically to your state. And while we always encourage teaching young people about finances, in situations of money that will eventually be theirs we recommend using discretion when sharing information with them. A child that knows their college is paid for has less incentive to work hard and earn scholarships/finish in a timely fashion.
As with other investments, there are generally fees and expenses associated with participation in a 529 plan. There is also a risk that these plans may lose money or not perform well enough to cover college costs as anticipated. Most states offer their own 529 programs, which may provide advantages and benefits exclusively for their residents. Investors should consider, before investing, whether the investor’s or the designated beneficiary’s home state offers any tax or other benefits that are only available for investment in such state’s 529 college savings plan. Such benefits include financial aid, scholarship funds, and protection from creditors. The tax implications can vary significantly from state to state. Please consult a qualified tax professional to discuss tax matters.
