Savings for kids: What are your options?

Quick insights

• Adults looking to help children save for the future have several options.
• Some savings accounts are designed for this purpose and include custodial accounts and other savings plans.
• Additional options, such as long-term savings plans, can offer unique advantages.

When it comes to saving money to use for your children later, you’ve probably heard some common advice: the earlier, the better. On the one hand, opening a savings account for a child at any age helps parents and guardians prepare for that child’s future. On the other hand, a savings account can help show older children how to build financial habits.

In this article, we’ll review the pros and cons of various savings options that parents and guardians have to help their children.

A child savings account

A child savings account can be defined as a joint account held by a parent and child. The parent or guardian has control over the account; however, the child may be able to transfer money in and out of the account and manage the account through various activities, such as deposits, transfers and withdrawals.

Pros

• The child may be able to manage the savings account in person or digitally with banking tools, such as a mobile app.
• Monthly fees may be low or waived with lower minimum balance requirements than savings accounts for adults, but it ultimately depends on your banking institution.

Cons

Depending on the type of savings account, the child may be able to withdraw money before turning 18, which may not align with every parent’s financial plan.

Custodial account

A custodial account can serve as a savings tool for longer-term savings. A custodial account is set up by an adult, often a parent or guardian, on behalf of a minor.

Unlike a joint savings account, the child cannot manage the account. The custodian does so on behalf of the child. Once the child reaches the age of majority (which varies by state), the custodian has a duty to turn the account over to the child at which point they can manage the money in the account as they see fit. Alternatively, they can move the money into a new checking or savings account.

Pros

• The custodian can deposit money into a custodial account without fear that the child will make a withdrawal before age 18.
• Custodians can manage money in the account in standard ways, including withdrawing, transferring and depositing.
• Money placed in a custodial account has the potential to earn interest and grow over time.

Cons

• The money in a custodial account may affect a child’s qualifications for financial aid for college.
• Custodial accounts may be subject to stipulations.

Long-term college savings plan

Part of planning for a child’s future may be saving for college. A long-term savings plan is designed to help you reach your education savings goals. This type of savings plan is helpful to parents because of its unique benefits.

Depositing money in a long-term college savings plan has an annual limit but comes with advantages:

Pros

• The account is designed for funding a child’s K-12 and post-secondary education.
• Money in the account can be used to fund qualified educational expenses, including tuition, textbooks, vocational schools, K-12 expenses and even some student debt.

Tax benefits

There are several tax advantages when you use a long-term plan for college savings:

• Money deposited into the account and any interest earned may not be subject to taxes.
• Withdrawals may be made tax-free if the withdrawn money is used for qualified educational expenses.
• The account can grow tax-free, and the account holder can make tax-free withdrawals to cover qualified education expenses.
• Several states offer state tax deductions on contributions to long-term savings plans.
• You can change the beneficiary on the account to another eligible family member without paying taxes. This could include siblings, cousins, aunts, uncles, in-laws and step-relatives.

Cons

• Contributions to a long-term college savings plan may be subject to gift taxes.
• Withdrawals that are not used for qualifying education expenses are subject to a 10% penalty and income tax.

Trust fund

Setting up a trust fund requires an agreement between three parties: A grantor who provides the funds (you), a trustee who manages the funds and a beneficiary (the child) who receives the funds. Money placed in a trust fund cannot be accessed until the child turns 18, or a specified age dictated by the trust.

Because a trust fund involves a third party (the trustee), this type of savings account differs from other options that allow you to manage money directly. However, the grantor can set terms for how the assets in the trust should be managed, as well as choose a trustee who will manage the money fairly.

Pros

Trust funds offer certain advantages, one being that parents or other grantors maintain control over their finances while still providing for the next generation. Trusts can also offer estate planning and tax benefits:

• Assets in a trust can include cash, stocks and bonds, life insurance benefits, real estate and more.
• Families may use a trust fund to hold all or part of a child’s inheritance, which allows the trustee to oversee how it is spent until the child reaches a certain age dictated by the trust document.
• May reduce tax obligations for heirs, depending on your unique situation. Consult a tax advisor for advice.
• The grantor can decide to set the trust up in a way that allows the trust to pay the taxes on capital gains, interest and dividends, or the grantor can pay the taxes themselves.

Cons

• This setup is very detailed and may require help from lawyers and financial professionals. 
• Interest or capital gains accumulated in the trust have intricate tax implications.
• If a trustee is family or a friend of the family, decision making can become difficult when the child wishes to receive funds.

How to choose a savings option for your child

Decisions on how best to save for your child’s future are personal ones, and there’s no “correct” way to save. However, here are some considerations that can help you make choices as your child grows:

Consider the financial priorities of the child

If you’re creating a financial plan for an older child, invite them to take an active role in the process. A child with their sights set on higher education may wish to prioritize contributions to a savings and investment plan, for example. A child just starting to manage their money is another situation, and they may benefit from a child savings account.

Starting small may be better than not starting at all

Planning for a child’s future may feel overwhelming. Choose an option that feels most manageable today, and your savings strategy can grow along with you. Each savings vehicle has its own unique advantages with some accounts being simpler than others. Understanding your options and goals helps you make a more informed decision.

Consult a financial professional

An expert can help you weigh pros, cons and offer suggestions based on your budget and goals. A professional’s knowledge can raise new considerations as you decide which type of savings is best for your child.

In conclusion

If you’re an experienced saver, you likely already understand many of the savings options available to you. Now you should be more familiar with the savings options available to children and the potential pros and cons of each. Understanding these can help you prepare your loved ones for the future and pass on good financial practices to the next generation.