How to Save for Your Kids’ Future

Saving for a child’s future involves strategic financial planning to address various potential needs. Whether the goal is funding higher education, a home down payment, or a solid financial foundation, starting early and understanding available options can make a significant difference. Thoughtful planning allows families to maximize savings potential through tax advantages and investment growth, securing resources to empower children as they navigate adult life.

Education Savings Options

Preparing for escalating education costs is a primary concern for many families. Specific tax-advantaged accounts are designed to help, offering benefits that make funding future educational pursuits more manageable. Understanding their distinct features helps in selecting the most suitable option for a child’s academic journey.

A popular choice for education savings is the 529 plan, a state-sponsored investment vehicle offering federal and often state tax benefits. Contributions are made with after-tax dollars, but the money grows tax-free, and qualified withdrawals are also tax-free. Qualified education expenses encompass a broad range, including tuition, fees, books, supplies, and room and board at eligible post-secondary institutions. 529 plans also permit tax-free withdrawals of up to $10,000 per year per student for K-12 tuition expenses.

There are two primary types of 529 plans: prepaid tuition plans and education savings plans. Prepaid tuition plans generally allow account owners to purchase future tuition credits at current prices, while education savings plans function more like investment accounts, with earnings dependent on market performance.

While there is no federal annual contribution limit for 529 plans, contributions are considered gifts for federal tax purposes. For 2025, individuals can contribute up to $19,000 per beneficiary (or $38,000 for married couples filing jointly) without triggering federal gift tax implications. Each state sets its own lifetime contribution limits. Account owners retain control over the funds, and the beneficiary can be changed to another eligible family member if needed. Some states may also offer a state income tax deduction or credit for contributions, though this often requires contributing to the in-state plan.

Another option for education savings is the Coverdell Education Savings Account (ESA). Similar to 529 plans, contributions to an ESA are not tax-deductible, but earnings grow tax-free, and withdrawals are tax-free if used for qualified education expenses. A notable difference is that ESAs cover a broader range of expenses than 529 plans, including those for elementary and secondary education, such as tuition, books, and supplies, for both public and private schools. The annual contribution limit for a Coverdell ESA is $2,000 per beneficiary, regardless of the number of contributors.

Eligibility to contribute to an ESA is subject to income limitations, with contributions phased out for higher earners. Funds in a Coverdell ESA must generally be used by the time the beneficiary reaches age 30, or they must be distributed, potentially incurring taxes and penalties on the earnings, unless transferred to another eligible family member. While ESAs offer flexibility for K-12 expenses and a wide range of investment options, their lower contribution limits and income restrictions often make them a supplementary savings tool rather than a primary one, especially compared to 529 plans for college savings.

General Purpose Savings and Investment Accounts

Beyond specific education-focused accounts, several general-purpose savings and investment vehicles offer flexibility for various future needs, whether for education, a first home, or simply a financial head start. These accounts come with different levels of control, tax implications, and accessibility. Understanding these distinctions is important when deciding how to save for a child’s broader financial future.

One common choice is a custodial account, established under either the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA). With these accounts, assets are legally owned by the child but managed by a designated custodian, usually a parent, until the child reaches the age of majority, which is typically 18 or 21, depending on state law. Once the child reaches this age, they gain full control over the funds and can use them for any purpose, without restriction. Custodial accounts can hold a variety of assets, including cash, stocks, bonds, and mutual funds.

Contributions to UGMA/UTMA accounts are considered irrevocable gifts to the child, meaning the funds cannot be reclaimed by the contributor. While there are no specific contribution limits for these accounts, contributions are subject to the annual gift tax exclusion. For 2025, this means an individual can contribute up to $19,000 per recipient (or $38,000 for married couples filing jointly) without incurring gift tax.

A significant tax consideration for custodial accounts is the “kiddie tax.” For 2025, the first $1,350 of a child’s unearned income (such as interest, dividends, or capital gains) in a custodial account is generally tax-free. The next $1,350 of unearned income is taxed at the child’s marginal tax rate, which is often 10%. Any unearned income exceeding $2,700 is then taxed at the parent’s marginal income tax rate. This rule applies to children under age 18, or those aged 18 who do not have earned income exceeding half of their support, or full-time students aged 19 to 23 who also do not have earned income exceeding half of their support.

Another option is investing in U.S. savings bonds, specifically Series EE and Series I bonds. These are considered low-risk investments backed by the full faith and credit of the U.S. government. Savings bonds generally accrue interest that is tax-deferred until the bond is redeemed or matures, which can be up to 30 years. A notable tax advantage is that interest earned on both Series EE and Series I bonds is exempt from state and local income taxes. Furthermore, the interest may be excluded from federal income tax if the bond proceeds are used to pay for qualified higher education expenses, provided certain conditions are met, including the taxpayer’s modified adjusted gross income (MAGI) falling within specific phase-out ranges.

Series EE bonds are guaranteed to at least double in value over a 20-year period, even if additional interest must be added to meet this guarantee. Series I bonds offer a combination of a fixed interest rate and a variable rate that adjusts with inflation, providing protection against rising costs. Both types of bonds have an annual purchase limit of $10,000 per person for electronic bonds. All savings bonds must be held for at least 12 months before redemption, and a penalty of three months’ interest is applied if redeemed within the first five years.

Finally, parents can simply open a standard brokerage account in their own name with the intention of using the funds for their child’s future. This approach offers the highest degree of control for the parent, as the assets remain under their legal ownership and management. All investment income and capital gains generated within the account are taxed at the parent’s marginal tax rate. This avoids the “kiddie tax” rules that apply to custodial accounts, as the income is not attributed to the child. The primary advantage of a brokerage account in the parent’s name is the complete flexibility regarding how and when the funds are used, without the legal transfer of assets to the child at a specified age.

Fostering Financial Literacy in Kids

Beyond establishing various savings accounts, teaching children about money is an important step in preparing them for their financial future. Instilling good financial habits early helps them understand the value of saving, spending wisely, and giving back. These practical lessons can complement formal savings plans, equipping children with the knowledge to manage their own resources effectively as they grow.

Parents can actively involve children in the saving process by setting clear, tangible goals together. Using transparent jars labeled for “spend,” “save,” and “give” can visually demonstrate how money is allocated and help children grasp basic budgeting concepts. When children see their savings grow, it reinforces the concept of delayed gratification and the benefits of consistent effort. Opening a basic savings account in the child’s name, even with small initial deposits, provides a practical introduction to banking and earning interest.

Allowances can serve as a powerful tool for financial education, whether they are tied to chores or given unconditionally. This provides children with their own money to manage, allowing them to practice making spending decisions and experiencing the consequences. Discussing the difference between needs and wants during everyday shopping trips can further solidify their understanding of financial priorities. Parents can also consider matching a portion of their child’s savings, similar to an employer’s 401(k) match, to incentivize saving and illustrate the power of compounding. This practical experience helps children appreciate how their money can grow over time.