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How to Choose the Best Savings Plan for Your Child

How to Choose the Best Savings Plan for Your Child

December 20, 2021

At Compass Financial, our professional advisors often receive questions from parents and guardians who are looking for direction on how they can save money for their kids. We cover all of the different types of accounts that are available as well as what key points to consider before making a decision. Our goal is to help you find the best savings plan for your child – one that best fits your unique circumstances and satisfies your financial needs and goals.

By the way, if you’re looking for ways to save money for your kids specifically for educational purposes, we cover that in another blog all about college savings plans, so we won’t cover that here.

How to Save Money For Your Kids

Many of us know the sooner you start saving the better! Even if you put away a small amount of money each year, starting a savings plan for your child can quickly add up to great savings over time. The money you save for your child can help secure a better future for them. Whether your goal is to help them save for college, retirement, or to get an early start on a savings account, getting started today will only put your child in a better position tomorrow.

The Best Ways to Invest Money for a Child & Top Things to Consider

Before choosing the best savings plan for your child, there are a couple big questions you’ll need to answer: how much access you want your child to have to the money being saved and what amount will you contribute. We’ll cover all of the major items to consider when making these decisions. Below are the top three ways to invest money for your child as recommended by our financial planners.

Custodial IRA or Custodial ROTH IRA

This type of savings applies if the child is earning an income that’s taxable and if they have a W2 or 1099. This means that simple jobs like mowing the lawn or starting a lemonade stand will not qualify. However, if your child does have a W2 or 1099, this type of account can be extremely beneficial for them. Both are tax deferred and can lead to powerful compounding over the years.

It’s important to understand that there are a few key differences between these two types of savings plans. Be sure to take the time to dig into these differences or ask a professional advisor which option is best for you and most importantly, your child.

Uniform Transfer to Minors Act (UTMA)

If your child does not receive taxable, earned income and you’re the one who is making contributions on their behalf, this can be an excellent option. An UTMA allows you to invest after-tax dollars as well as a variety of other items such as real estate, royalties, patents and more. With an UTMA savings plan, a custodian will act as a fiduciary until your child is a majority. There are tax advantages for the donor, and they can contribute up to $15,000 per year.

When your child turns 21 (the age of majority in Iowa), they will become the owner of the account and assume control over all assets that have been invested into the account. This may or may not be a good choice for all kids, but the parents should consider this and encourage the child to make responsible financial decisions once they have access to the account. One item to note, a UTMA savings plan counts as an asset for the child and if the amount is large enough, it can significantly reduce the chances of your child receiving financial aid for college.

Individual Investment Account or Joint Account

The last recommendation of ours is to invest money for a child with an individual investment account, or joint account. These options give you control and the ability to decide together when your child is old enough to take responsibility over this asset. This option is great if your child doesn’t have earned income and you are not comfortable with them taking over the account when they turn 21.

There are however a few disadvantages to this option. The first being that you won’t receive tax benefits like the options mentioned above, and the second being that future distributions to your child, over $15,000 per person per year, wouldn’t be covered by the gift tax exclusion. Simply put, it is a savings account under your name that you will give to your child at a time of your and your child’s choosing.

Compass Financial Will Help You Determine The Best Savings Plan For Your Child

The bottom line is that, as a parent, you have many great options to invest money for your child and build significant savings over time which they can use when ready. For more guidance on choosing the best savings plan for your child or if you have questions about how to save money for your kids, contact our financial advisors to discuss your options and start saving today!

*The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.