There are many financial issues tied up with parenting today. Aside from paying for basic expenses and planning for a child’s college education, many parents are also concerned with teaching their children the basics of saving, investing, and providing for their fiscal well-being in the event of a tragedy.
All of these are important priorities, but many parents become overwhelmed at the prospect of figuring out how to manage their money effectively to be sure that all of their children’s present and future financial needs are being met. To provide financial security for their children, parents should consider these four essential accounts to get started:
A Basic Savings Account
Opening a plain-vanilla savings account for your child will provide an opportunity for you to teach your son or daughter the importance of saving. But don’t just open the account and force your child to contribute to it — dialogue with your child about why it’s important to save. This way, children will feel more empowered to make smarter financial choices.
While savings accounts are a very safe harbor for your child’s cash, having too much in savings when college application time rolls around could hurt your child’s chances of getting financial aid. According to current government rules, kids can have up to $3,000 in a savings account in their own name without it impacting their eligibility for college cash. Additionally, the interest you can earn in a savings account is very low.
A Custodial Account
If you want to invest in stocks, bonds or funds with greater returns for your children, you can open a Uniform Gift to Minors Act or the Uniform Transfer to Minors Act account at a brokerage firm. In most states opening UGMA and UTMA accounts allow you to give your child money on an annual basis without those funds being subject to the gift tax.
UTMA and UGMA accounts are tax-advantaged: the first $1,000 in interest they earn each year isn’t taxed at all; the next $1,000 is taxed at the child’s income tax rate which is typically around 5% for most children, and earnings beyond $2,000 per year are taxed at the parent’s income tax rate. However, it’s important to note that parents relinquish control of this money when the child hits 18 or 21, depending on the state. This means that once they’re no longer children, they’ll have full control of the account and can choose to spend the money you invested for them in any manner they wish.
A 529 Plan
529 plans have become increasingly popular in recent years as a way to save for a child’s college education. These accounts are often compared to 401(k)s because they are funded by parents with pre-tax money and funneled into an investment that will grow over time.
However, unlike a 401(k), if the money saved in the account is used for its intended purpose for educational expense, the interest earned is never taxed. For this reason, 529 plans are a huge boon to both the children, who will benefit from the savings, and the parents, who will get a tax break.
A drawback to 529 plans is that they must be used for expenses related to higher education. This means that if your child decides not to go to college and you have no other children to transfer the funds to, you’ll have to pay income taxes on the money you’ve saved and a 10% penalty.
A Term Life Insurance Policy
Losing a parent is an emotionally devastating situation for a child to be in, so guard against financial devastation by purchasing a term life insurance policy as soon as your child is born.
Although not technically an “investment,” life insurance is an invaluable form of protection against your lost income if you die before your child has reached adulthood. The good news is that term policies are relatively inexpensive — depending on the level of coverage you choose. You’ll probably only pay $50 to $100 per month if you’re in good health. The only drawback to buying life insurance – if you can call it one – is that the policy may never be used. But the peace of mind it will provide is truly priceless.
Raising a child is definitely expensive, but you don’t have to break the bank to provide a healthy and secure financial life for your child. By investing in these accounts early, you can adequately prepare for your child’s future.
Hannah Kim is a financial writer at NerdWallet, a site dedicated to helping consumers learn how to manage their money, whether it’s to help them find the best credit cards for their needs or find the best car insurance.