“It’s never too early to start saving.” You’ve probably heard a million people tell you that in the context of retirement — but what about saving money for kids?
We all worry about what will happen to the children in our lives as we get older. But one way to make sure you can rest easy is to put money aside for those kids to help them build a financial future. Unfortunately, knowing where or how to start saving for children doesn’t come second nature to all of us.
The good news is that there are loads of incredible and flexible savings tools and investment vehicles out there that can help you save money and assets for the kids you love.
It’s important to note that saving and investing are different — and they are useful strategies for different purposes. Saving is going to be helpful for creating an emergency fund, while investing is better for building wealth long-term.
This guide will explain why you should save money for kids, when you should start saving, and the best ways to save and invest for kids.
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Why Should You Save Money for Kids?
Before we talk about the best ways to save money for kids, let’s slow down and talk about how saving actually works.
How savings works
In its most basic form, saving is the simple act of putting away money for the future. You could be saving for a future expense or need or simply squirreling away for a rainy day.
Regardless of why you’re choosing to save, saving money can be a short-term or long-term practice.
Savers will normally deposit money into a low-risk bank account that can be accessed for use almost immediately if the cash is ever needed.
There is a range of savings account options that let savers earn a bit from their money by offering an annual percentage yield (APY), which is the yearly interest rate you make off of your savings. As a point of reference, the average savings account APY is currently 0.06%.
There are plenty of high-yield savings account products that offer an APY above that national average. But these account types tend to come with rules on meeting monthly balance requirements or leaving your cash untouched for a certain amount of time, and so these are really medium or long-term savings solutions.
Advantages of saving
Regardless of how or why you decide to save, establishing a savings account can be a life-saver in the future.
25% of Americans have no emergency savings. That means a quarter of families aren’t going to have any funds to fall back on if a car breaks down or somebody loses a job.
And there are a range of benefits for both yourself and the children in your life that go hand-in-hand with putting money in a savings account:
- You’ll know where you stand from the get-go. Most savings account providers tell you upfront the amount of interest you’ll get on your balance. This makes it easy to plan your finances for the future as you save.
- You’ll benefit from easy access to your cash. Certain products like a certificate of deposit (CD) account will probably penalize you with an extra charge if you want to access your cash before the account has matured.
But most savings accounts are pretty liquid, which means that you can get your money as soon as you need it — that makes it a lot easier to get work done immediately if the boiler breaks down.
- Saving is a low-fee way to put money away for the future. Maintenance fees, or the money the bank charges you for having the account, are quite low.
That being said, you’ve got to look out for Regulation D violation fees. Regulation D is a federal law that basically says you can’t make more than six transactions out of a savings account in a single month without paying a fee.
It’s also important to note that the money you place in savings accounts is protected by the Federal Deposit Insurance Corporation (FDIC). The FDIC guarantees the money in your savings account up to $250,000. That means if something happens to your bank, you’ll still get your savings back.
Disadvantages of saving
Saving is pretty easy to do. There’s not much of an upfront cost or any tricky learning curves.
There are a couple of disadvantages to be aware of, though.
When you save, returns are generally low — and this is one of the key differences between saving and investing.
Investing is when you buy an asset with the goal of generating income through that asset or its value appreciating over time. By “assets,” we’re specifically talking about financial securities like stock shares, bonds, exchange-traded funds (ETFs), and mutual funds.
Unlike a normal saving plan, most financial securities aren’t designed to be liquidated at the drop of a hat as part of a short-term cash strategy. Investing is more about shoring up your financial future in the long term.
As a result, investment products normally have way higher rates of return than savings accounts do. That means you can make your money work harder for you and end up earning more over time through investment.
These low rates of return that savings accounts bring in can also be a problem if inflation rears its ugly head while you’re saving — because savings accounts can be outstripped by inflation.
Translation: while the dollar amount may not go down in a savings account like it might if the cash were invested, a loss of purchasing power is equivalent to “losing money” over the long term. You aren’t going to run into that problem with most investment vehicles. That being said, there's an element of risk investors must contend with.
When Should You Start Saving Money for Kids?
The short answer is: as soon as possible. By saving early, you’ll have more time to build the children you love a bigger nest egg that will give them the financial freedom they need later in life to chase their dreams.
For saving for a rainy day or a specific financial goal in the short term, it’s a great idea to set up a savings account in a child’s name at an early age — even from birth.
But if you’ve got your eye on their long-term financial futures all the way from college up until retirement, you may want to consider investing versus saving.
That’s because the APY on most savings products is fairly low — and if you really want to build wealth to pass on to the kids you love when they come of age, investing in assets that generate higher levels of compound interest over time is really the way to go.
But starting to save early isn’t just about having more time to build financial wealth for a child. It’s also about helping them build their financial literacy.
According to the U.K.’s Money Advice Service, most kids have their money habits set by the age of seven. Likewise, another study done by Washington University in St. Louis revealed that kids with savings accounts in their names are six times more likely to go to college — no matter how much money is in those savings accounts.
Translation: by either saving or investing for a child, you’ll be able to instill positive financial literacy skills and motivate them to pursue bigger and better financial goals. That’s why you should consider saving and investing, and that’s also why it’s never too early to start.
Which Savings Account is Best for a Child?
If you’re determined to set up a savings account for a child in your life, you’ve got a lot of options.
Loads of banks and credit unions offer youth savings accounts for kids under the age of 21 — although some banks might cap this age at either 12 or 18.
Generally speaking, a kids savings account will require an adult to serve as a custodian or claim joint ownership if the child is under 18 years old. That means the adult account holder has full access and transactional authority over the account. In turn, the child will have some limits on what they can do with the account.
A lot of children's savings accounts tend to pay higher interest rates than adult accounts to incentivize kids to start saving early. But it’s important to note that this higher APY is counterbalanced by a balance cap.
Every bank offers its own type of youth savings account. You’ll likely encounter regular deposit savings accounts, certificate of deposit (CD) accounts, and money market savings accounts.
To determine which savings account is best for a child, you’ll need to do your homework and compare these features of each account:
- Account APY
- Deposit requirements
- Monthly fees
- Minimum balance requirements
- Matching programs
- FDIC insurance
But don’t forget: while opening up a savings account is a great way to gift a kid money in the short term, returns are low. If it’s the long-term you’re thinking about, you should really consider investing for that kid too.
What is the Best Investment Plan for a Child?
If you’ve got your eye on the long-term and truly want to build sustainable wealth for a child’s future, investment is definitely the way to go. But there are a few different types of investment vehicles available to you — and they’ve all got their own unique sets of pros and cons.
To help you get started, we’ll quickly break down three of the most popular ways to invest for children.
Custodial accounts
A UGMA custodial account is an investment vehicle that lets an adult save money for kids to access and spend when they grow up.
When you set up a custodial account as an adult with a provider like EarlyBird, you’re responsible for managing the assets in that account until the child reaches the "age of majority." That age is a little bit different in certain states, but it’s normally either going to be 18 or 21.
When the child beneficiary hits that age, the custodianship ends and everything in the account passes on to their control.
Unlike some other saving and investment products, custodial accounts aren't limited by what somebody thinks is a "qualified expense." After coming of age, the kids you’re saving for can use the money and assets however they want to.
The assets that kids get when they take ownership of a custodial account are gifts with no strings attached.
In terms of taxes, income made through a custodial account benefits from the Kiddie Tax. This is a special IRS rule that dictates unearned income is taxed at the child’s lower tax rate rather than the adult custodian’s higher rate — but only up to a certain threshold. That can save families a lot of money in tax dollars.
You’ll also benefit from the gift tax, which allows any person to gift up to $16,000 per year without having to pay taxes on that gift. That means that if you’re married, you and your spouse can gift up to a combined $32,000 per year.
Because a UGMA gives you so much time to save for a child’s future, they’re ideal for newborns or toddlers. If you want to learn more about UGMA custodial accounts and why they’re a great way to invest for kids, let us walk you through it.
529 plans
If you want to save money for kids exclusively in the context of paying for college, a 529 plan is worth exploring. But there are a few key differences between 529s and custodial accounts you should be aware of.
A 529 college savings plan is an investment account that lets parents, guardians, or other adults invest money in a child’s future education. Each state in the U.S. has its own 529 plans — and although contributions you make to a 529 aren’t tax-deductible, unearned income generated by your investments grows tax-free.
The major con with 529 plans regarding saving for kids is that you can only take money out for a “qualified” education expense. If you’re worried about how to pay for college, a 529 plan would normally cover all your basic college tuition fees and administrative fees. Some plans even cover on-campus accommodation or a dorm meal plan.
But other essentials like off-campus accommodation, food, books, and travel don’t usually fit the bill. That’s why a lot of parents that go for a 529 plan will still opt to set up a custodial account too.
You’ve also got to consider the possibility that the child you’re saving for might not even want to go to college when they grow up. After all, future education plans are hard to predict a decade or more in advance.
If this happens to you, it doesn’t mean that all of the money you’ve saved is lost forever. But you’ll have to pay income taxes on your withdrawals plus a 10% penalty on any of the unearned income the child’s account generated through dividends or compound interest.
Custodial Roth IRA
A Roth individual retirement account (IRA) is an investment vehicle that lets you deposit cash or other assets so that it can grow tax-free — as long as you leave it untouched until retirement.
While most kids aren’t thinking about retirement yet, you can set up a custodial Roth IRA to save money for kids. But it’s important to note that the money you save in a custodial Roth IRA needs to be income the child has generated.
That means the custodial Roth IRA is perfect for older kids who are making money babysitting or mowing lawns. They aren’t ideal for younger children because those kids won’t be old enough to work.
The biggest benefit of the custodial Roth IRA is that you can withdraw cash tax-free. That can save you loads of money — but again, you can only withdraw after you’ve hit retirement age. If you try to make withdrawals before you or the named beneficiary retire, your provider will likely hit you with cash penalties.
It’s also important to note that contribution limits to Roth IRAs are low. Currently, the IRS limits contributions to just $6,000 per year. For a kid mowing lawns, that’s probably not a big issue. But if you’re trying to create a big nest egg for a child’s future, a Roth IRA is a slow burner.
Conclusion
Generally speaking, saving tends to be all about establishing a short-term “rainy day” fund. Savings accounts are ideal for ensuring you always have emergency fund cash savings that you can withdraw at the drop of a hat.
But if you want to make your money work harder and save more for the kids in your life, you’ll want to consider complementing a savings account by setting up an investment plan too. By striving to both save and invest, you’ll be able to make sure you’ve covered all your bases.
At the end of the day, the savings account or investment plan you choose for the children you love will depend on a lot of factors unique to your situation. But if you want a tax-efficient and uncapped way to invest in a child’s financial future, setting up a UGMA custodial account through EarlyBird is going to be your best bet.
Are you ready to start saving money for the kids you love? Download the EarlyBird app now.
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This page contains general information and does not contain financial advice. All investments involve risk. Any hypothetical performance shown is for illustrative purposes only. Actual investment performance may be different for many reasons, including, but not limited to, market fluctuations, time horizon, taxes, and fees. Please consult a qualified financial advisor and/or tax professional for investment guidance.
