In honor of National 529 Day (May 29th, 5/29... Get it? 😉 ), I thought I'd tackle one of the number one questions I get asked about from parents:
What is the best savings option for my child?
You might even be asking yourself; do I need a savings account for my child? Do I need to save for my children's future education? The answer to these questions is that it really is personal. Think back on your own childhood. Did your parents have a savings account for you? Did it make an impact on your life? If you didn't have a savings account, would having one available to you as an adult have made an impact on your life? If you decide that saving in some capacity for your children's future is of importance to you, here is a breakdown of some common savings options and my go to recommendations for clients:
Traditional Savings Account
Pros:
- Safety: Bank accounts are FDIC-insured, so if the banking institution goes under, your money is protected up to certain limits. This makes bank accounts one of the safest investments you could make.
- Liquidity: the funds are readily available for you to have access to (maybe this is also a con 🤷♀️).
Cons:
- Low Returns: A trade-off of safety is a lower return. You will likely earn a lower interest compared to other investment options.
- No Tax Benefits: any interest earned is subject to federal and state income taxes.
529 College Savings Plans
Pros:
- Tax Benefits: Your contributions will grow tax-free, and withdrawals may be tax-free if used appropriately for qualified higher education expenses.
- Greater Returns: You can invest your contributions, allowing you greater earning potential than a traditional savings account.
- Higher Contribution Limits – Many plans offer high contributions limits that are exempt from gift tax.
- Flexibility: Funds can be used for a variety of education-related expenses, including tuition, room and board, books, and even K-12 tuition in some cases.
- State Income Tax Deduction: If you opt for your State Sponsored 529 Plan, many offer some type of tax deduction or credit for contributions made to their plan.
Cons:
- Penalties for Non-Education Use: Withdrawals for non-qualified expenses incur taxes and a 10% penalty on earnings.
- Investment Risk: Funds are subject to market risk, meaning there is a risk of losing the money that you have invested in the market.
Custodial Accounts (UTMA/UGMA)
Pros:
- Flexibility: Funds can be used for any purpose that benefits the child, not just education.
- Control: Once the child reaches the age of majority (18 or 21, depending on the state), they gain full control of the account.
Cons:
- Financial Aid Impact: Assets in these accounts are considered the child’s and can significantly affect financial aid eligibility.
- Irrevocable: Contributions are irrevocable and legally become the child’s property once they reach the age of majority.
Roth IRAs for Kids
Pros:
- Tax-Free Growth: Contributions grow tax-free, and qualified withdrawals in retirement are tax-free.
- Retirement Savings: Encourages long-term savings habits and provides a head start on retirement savings.
Cons:
- Contribution Limits: Contributions are limited to the child’s earned income, with a maximum limit (e.g., $7,000 in 2024).
- Penalties for Early Withdrawal: Early withdrawals before age 59½ for non-qualified expenses may incur taxes and penalties.
If you're looking to just get started, opting for a traditional savings account is a great first step. It then may make more sense to move into an option that allows you to invest, but make sure you're factoring in longer-term planning and considering the impact on your financial strategy when making that decision.