What Should I Do With My Child’s Money?

Managing a child’s money requires thoughtful planning to support their future. Establishing financial accounts early allows investments to grow over many years. This builds a foundation for financial resources, assisting with major life events or securing long-term stability.

Defining Your Financial Goals

Before choosing any specific financial product, clarifying the purpose of the funds is an important first step. Different financial goals align with different account structures and investment strategies. For instance, saving for a college education might lead to one type of account, while building a general financial safety net could indicate another.

Many parents consider saving for higher education expenses, such as tuition, room, and board. Other common objectives include contributing towards a child’s first car purchase or accumulating funds for a down payment on a future home. Some families aim to create a general nest egg that the child can access upon reaching adulthood, providing a flexible financial resource for their independent life.

Identifying specific goals helps narrow down available savings and investment vehicles. A clear objective guides decisions about investment duration, risk level, and advantageous tax implications. This ensures the chosen financial pathway aligns with the family’s long-term aspirations for their child.

Exploring Savings and Investment Options

Several common savings and investment vehicles exist for children, each with distinct features regarding ownership, tax treatment, and usage. Understanding these options is foundational to making informed decisions.

529 Plan

A 529 plan is a state-sponsored education savings plan that allows tax-advantaged growth for qualified education expenses. An adult owns the account and retains control, while the child is the beneficiary. Funds grow tax-deferred, and withdrawals are tax-free if used for qualified educational expenses, including K-12 tuition. Unused 529 funds, subject to conditions, can be rolled over to a Roth IRA for the beneficiary.

UGMA/UTMA Accounts

Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA) accounts are custodial accounts that allow adults to gift assets to a minor. The custodian manages the assets on behalf of the minor, but the assets are legally owned by the child. Investment earnings within these accounts are subject to the “kiddie tax” rules once they exceed certain thresholds. Upon reaching the age of majority, the child gains full control over the assets with no restrictions on how the funds are used.

Custodial Roth IRA

A Custodial Roth IRA provides a way for a child with earned income to save for retirement on a tax-advantaged basis. The account is held by a custodian for the benefit of the minor, but contributions can only be made from the child’s earned income. Funds grow tax-free, and qualified withdrawals in retirement are also tax-free. For 2024, the maximum contribution to a Roth IRA is $7,000, or the child’s earned income, whichever is less.

Traditional Savings Accounts and CDs

Traditional savings accounts and Certificates of Deposit (CDs) are straightforward options for holding a child’s money, offering lower returns compared to investment accounts but with greater principal safety. These accounts can be opened in the child’s name, often with a parent as a joint owner or custodian. Interest earned on these accounts is taxable income and may be subject to the kiddie tax rules. CDs offer a fixed interest rate for a predetermined period, providing predictable returns but limiting access to funds until maturity.

Selecting the Right Account Type

Choosing the most suitable account type involves evaluating your financial goals against the characteristics of each option. Factors like control over the funds, flexibility of use, tax implications, and potential impact on financial aid are important considerations.

Control Over Funds

With a 529 plan, the account owner retains control and can change the beneficiary or withdraw funds, though non-qualified withdrawals may incur taxes and penalties. In contrast, UGMA/UTMA accounts transfer full control to the child upon reaching the age of majority, meaning the child can use the funds for any purpose. A Custodial Roth IRA also becomes the child’s upon adulthood.

Flexibility of Use

A 529 plan is designed for educational expenses, offering tax benefits tied to qualified withdrawals. UGMA/UTMA accounts offer complete flexibility once the child reaches the age of majority, allowing the funds to be used for anything from a car to a business venture. A Custodial Roth IRA is primarily for retirement savings, with tax-free growth and withdrawals for qualified distributions in retirement.

Tax Implications

While 529 plans offer tax-free growth and withdrawals for qualified education expenses, non-qualified withdrawals can be subject to income tax and a penalty. UGMA/UTMA accounts may trigger the kiddie tax on investment earnings, potentially subjecting a portion of the child’s income to the parent’s higher tax rate. Custodial Roth IRAs provide tax-free growth and tax-free withdrawals in retirement, and contributions are made with after-tax dollars.

Financial Aid Eligibility

Assets held in a parent-owned 529 plan are generally assessed at a lower rate in federal financial aid calculations compared to assets held directly in a child’s name, such as an UGMA/UTMA account. Assets in a Custodial Roth IRA are not reported as an asset on the Free Application for Federal Student Aid (FAFSA).

Contribution Limits and Rollover Options

529 plans generally have high lifetime contribution limits set by individual states and allow for beneficiary changes within the family. Custodial Roth IRAs have annual contribution limits tied to the child’s earned income. Recent legislation allows for limited rollovers from 529 plans to Roth IRAs, offering increased flexibility for unused education funds.

Teaching Financial Literacy to Children

Involving children in financial discussions and decisions provides a practical education in money management. This hands-on approach helps them understand the value of money and the importance of responsible financial habits.

Introducing an allowance can be an effective tool for teaching budgeting basics. Parents can structure allowances to include categories for spending, saving, and even giving to charity. This teaches children to allocate their money intentionally and to make choices about how their funds are used.

Discussing the concept of saving for specific goals, like a desired toy or experience, helps children grasp the benefits of delayed gratification. Parents can also introduce the idea of earning money through chores or age-appropriate tasks, connecting effort directly to financial reward. This demonstrates the relationship between work and income.

As children grow older, parents can introduce more complex financial concepts. Explaining how interest works on savings, or how investments can grow over time, provides foundational knowledge for future financial independence. Discussions about wants versus needs can also begin to shape their understanding of financial priorities.