How to Save Money for Your Children
When it comes to our kids, we all want the best for them. One major goal as parents is to raise them to be financially independent and responsible. We want to be able to give them the things we didn’t have but also be confident that they won’t blow it as soon as they receive it. The big question, though, is:
How do you start saving for your kids?
We get this question a lot from clients, so wanted to share the same 5 steps we take our clients through so you too can immediately start saving money for your children and make sure they have a bright financial future ahead of them.
5 Steps to Start Saving Money For Your Children
Step 1: Establish your S.M.A.R.T. financial goals (Specific, Measurable, Attainable, Realistic, Time Specific)
Determine what you want to fund for your kids besides their basic needs.
It’s very easy to narrow your focus on just saving for college but you want to keep an open mind and really think about your child’s entire lifetime. What kind of lifestyle do you want to be able to provide for your children?
Besides saving for college, here are some other financial goals you may want to consider for your kids:
- Annual travel experiences
- Summer camps and extracurricular activities
- Help them pay for their first home
- Pay for all or some of their wedding
- Leave a legacy at the time of your passing
- Fulltime nanny
- Private school K-12
Establish your time horizon to meet your goals
Another factor you must consider in planning for you children’s future is how much time you have to save for a particular financial goal. For example, if you have an infant who was just born and you have a goal of sending her off to private school in 6 years, that means you have a 6-year time horizon to accumulate enough money to cover the 3 years of tuition.
Dream big, but make sure you’re being realistic
Although we encourage you to go after your dreams, we also want you to be grounded in your current reality. Determine whether you can realistically stick to a specific savings plan without stretching yourself thin and mentally driving yourself nuts. Consider the stage of life you are currently in and your net household income.
A person making $50,000 a year with a savings goal of saving $45,000 a year is simply unrealistic.
Example of a Goal that is NOT SMART
I want to save for my kid’s college when she turns 18. This goal has a time element but it’s missing a lot of details to help you start planning. See the example below of what your savings goals should look like to start putting a plan in place.
Example of a SMART Goal
My kid is currently 5 years old and I want to pay for her college tuition once she turns 18. I’ll save enough to at least cover a public university in Georgia. Based on the average cost of college today in Georgia of $10,000 annually and assuming that average inflation for college tuition is 6%, I need to begin saving at least $291 per month for the next 15 years with an average rate of return of 6% so I’m keeping pace with inflation. By the time my kid goes to college – if she goes – I expect to have saved by then $93,307 if I consistently stick to this savings plan. Based on my current discretionary income – after all fixed and variable expenses are covered – I can afford this monthly savings goal.
Notice how this has a specific time horizon that includes a beginning date and an end date in which to save. Also, a specific final dollar amount is determined. You’re not saving just to save, with no idea of how much total you need at the very end! Also, inflation and rate of return is factored in as well so you know how much growth you need in order to keep pace with the rising cost of college.
Step 2: Determine the appropriate account to save AND invest towards that goal
Now that you created your savings goal, let’s talk about WHERE to put your money to start saving for your children.
Below is a list of different types of accounts to consider using. Not every account is suitable for every goal, so be sure you open and contribute money to the appropriate one based on your goals and tax mitigation strategies.
529 plan or qualified tuition plans
Arguably the most recognized (due to heavy marketing), a 529 plan is a tax-advantaged account designed to help you pay for qualified education expenses such as tuition, books, and housing. There are 2 types: prepaid tuition plan and education savings plan.
529 plans are very restrictive as far as what you can use it for. If you want to buy your kids a new car or laptop for college and you withdraw money from the 529 plan to pay for it, you may encounter taxes on the earnings and a penalty. This account is strictly for specific qualified expenses such as a tuition, and you have to pay the institution directly.
Check out this list of expenses you can use the 529 to pay for.
In the past, 529 accounts were solely for college expenses only. The 2017 Tax Cuts and Jobs Act allowed account holders to use money saved in the 529 account to also pay for private, public or religious K-12 tuition.
With college costs nearly doubling every 9 years, it’s no wonder that college is usually the first “goal” thought of when you think about saving for your children. However, there are so many other variables and life events that happen in your child’s life that you need to broaden your focus so you’re not putting all of your assets into a single account.
UTMA (Uniform Transfers to Minors Act) account
An UTMA allows for you to be the primary owner on the account until the minor reaches the age of maturity, as defined by local state law – usually age 21. In other words, you can open this type of investment account, deposit money into it, and once your kids turn 21, the entire account will be turned over to them. With this type of you account, you have much more flexibility regarding what purposes you can use it for without incurring any penalties. Also, it works just like a regular brokerage account in that you have more investment options than a 529 plan. The only drawback to this type of account is that your kid will own the account after they turn of age. What if your kid is a spendthrift or isn’t responsible with money yet?
Again, do not put all your money into this account since you don’t know what kind of money habits your kid will have.
You can use the Roth IRA for many purposes besides saving for your own retirement. If your kid goes to college, you can use the money inside the Roth IRA to put towards college tuition directly without a penalty. Annual contributions are limited to $6,000. Also, if your kid is 14 years or older and has earned income, you can open a Roth IRA for your kid and both of you can defer money into it. This is a great way to help your kid to think long-term. You’re giving your child a head start by opening one in their name when they start working and earning at their first job (they must have earned income for the account to be titled in their name).
Brokerage Account (aka Investment account)
You can own these accounts jointly with as many other owners as you like or you can hold it singularly. Typically, we have our married clients jointly titled on the account and have a TOD (Transfer on Death) on file to list beneficiaries should both spouses die.
You can also jointly own the account with your kid to save for other goals such as teaching them how to invest, save for college, cars, trips, or whatever goal you have. You only pay taxes on any capital gains realized and on dividends and interest earned in the account. You can also use these accounts to teach your children about investing.
The common thread between Roth IRAs, 529 plans, UTMAs, and Brokerage accounts is that, in all these accounts, you are able to invest, not just save the money and let it sit in cash like you would see in a regular savings account from a bank. With 529 plans, however, the investment options are limited to the financial institution. They will only offer a handful of mutual funds to choose from. Whereas with the Roth IRAs, UTMAs, and Brokerage accounts, you are open to the entire investment world. This is an opportunity for your children to learn how to track their investments and see their money grow over time.
[Click here to download your Financial Planning Checklist and Calendar to make sure you stay on top of your money throughout the year.]
How to choose the appropriate account
To choose which account to open, consider the following questions:
- Do I want to be able to easily withdraw from the account without penalties?
- How soon will I need the money from the accounts?
- How often will you access the accounts?
- Do you want investment option flexibility?
- What tax benefits are you looking for?
If you want the most flexibility and the option to withdraw money without penalty, a brokerage account may be the best option. If you want more restrictions on the use of the funds but want tax free growth, then consider the Roth IRA or 529 plan. If you want to gift to your children no matter how they turn out, then consider a UTMA.
For our clients, we typically open Roth IRAs, 529 plans, and brokerage accounts and have our clients contribute to all three accounts in various dollar amounts based on their time horizon of when they will need the funds and the tax mitigation strategy involved.
Step 3: Set up recurring contributions
This is where you hit the pavement. This is the step where you determine how much money to contribute on a regular basis into the accounts you set up to begin saving for your children.
Contributions can be automated to ensure that you keep making consistent progress towards your goal. Figure out how long you have until you want to use the money and then divide into bi-weekly or monthly contributions (based on when you get paid). Once you make the initial setup, you won’t have to think about it again unless you want to change the amount or frequency.
Also, you can make lump sum, one-time annual contributions if that is easier.
No matter the frequency, the key is to start and stay consistent with the savings plan.
Step 4: Review your financial plan regularly
Sit down at scheduled times throughout the year and assess how your plan is working.
These financial plan review dates can be done monthly or quarterly. If you’ve never done this before, start with a quarterly review. Make sure to write this date down and set it as a recurring calendar date so you don’t forget. Developing good money habits isn’t just about saving money; you have to check-in with yourself to see if you’re still on track to meet your goals.
Here are some questions and prompts to ask yourself during the review:
- What is the current balance of all the accounts?
- How has each account performed since inception?
- Do you need to increase your contributions? Can you afford to contribute more money into the accounts?
- If you’re saving for childcare, are there any prepayment incentives?
- Are there any upcoming salary bonuses or any other larger amounts of cash coming in the next quarter where you can make a lump sum contribution to your accounts?
- How have the financial markets performed year-to-date? Do you need to make adjustments to your investment allocation inside your accounts?
[Click here to download your Financial Planning Checklist and Calendar to make sure you stay on top of your money throughout the year.]
Step 5: Hire a professional to help you plan for your kids’ future
This is an optional step, but it doesn’t hurt to get a second opinion of whether you have the proper account types open and are putting enough money into each of them to meet your savings goals for your children.
If you already have a financial advisor or are in the market for one, it may be time to reach out to them for a review of your plan. Regular check ins and meetings will help you monitor your progress and help you avoid costly mistakes. Having a professional can help you stay accountable to your goals and may increase the likelihood of you succeeding.
Fee only advisors are the best to look for as they do not charge commissions or hassle you with additional products and services. They purely are objective in their advice-giving.
As a fee-only firm, we charge a retainer fee, an hourly rate and if we manage your investments, you are charged a percentage of your investment assets. If you would like to meet with us, click here to access our calendar directly to set up your complimentary discovery meeting.
Bonus Savings Tip: Invest In Yourself
Using your income to reinvest in your children instead of putting it into an account is also a valid investment for your children. In other words, invest in your own professional and career development to increase your earnings.
Increasing your earning power allows you to cash flow some of the goals you have for your children instead of having to save.
Also, don’t sacrifice your retirement savings. There are no loans for retirement but there are scholarships and loans for education. You should have your own retirement accounts fully funded before you contribute to your kids’ savings.
The Bottom Line:
Saving for your children is not a one-size-fits-all issue. There is a wide variety of options for you to accomplish the financial goals you have for your children.
Focusing in on the reason why you want to save for your children will help you lay out a map that you can use to reach your goals. This is an opportunity to teach your children about money so that when they do receive your financial gifts, they are educated and fiscally responsible enough to maximize the benefits.
Increasing your earning power improves your ability to not only cash flow some of your goals but to accomplish more with them as well.
The best way to save for your children is the well-researched way and working with a professional to validate your goals and plan. A little due diligence, thoughtful planning, and consistent contributions can pay off well later.
For more information about how to save for your children, check out Helen’s interview on the Brown Ambition podcast Episode 264 .