financial literacy

How Do You Start a Baby Savings Plan?

April 20, 2022

The first time you hold a newborn baby in your arms, your life will change forever. You’ll have a range of new responsibilities, jobs, costs, and concerns — and one of the biggest concerns all parents, grandparents, godparents, or any other friends and family inevitably have is to make sure that baby's financial future is taken care of.

Having a baby is almost as expensive as it is exciting. That’s why you owe it to the little bundles of joy in your life to develop a baby savings plan and consider how you can grow that savings through investment.

This guide explores when you should start building savings for a baby, the differences between saving and investing, the best baby savings account types, and the best investment plan for a baby.

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When Should You Start Building Savings for a Baby?

You don’t have to be an experienced parent of four to know that having a baby is expensive.

According to the US Department of Agriculture, your typical middle-income family is going to spend more than $12,000 in child-related expenses every year. And that number doesn’t even include all of the initial expenses you’ll need to consider, like all of your baby necessities and out-of-pocket medical costs.

Translation: you’re going to want to have a decent amount of money saved by the time your baby arrives — which means if you’re focusing on saving for baby-related expenses, it’s best to start saving long before that baby is even born.

But there’s another aspect of saving for a baby you’ll need to consider, too. In addition to saving for future child-related costs, you should also consider saving for your child’s longer-term financial future.

Illustration of woman and baby seated below giant shield

In terms of saving for a child’s future, it’s never too early to start. You can build savings for that child long before they’re even born — although with some saving or investment vehicles you might need to wait until the child is born.

But we’ll get to your investment options in just a minute. First, let’s take a look at the difference between saving for a baby and investing for a baby.

Saving vs. Investing for a Baby: What’s Right For Me?

When it comes to building a financial future for your baby, you’ve generally got two choices: you can save or invest. Ideally, you should try to do both — we’ll explain why.

Saving money tends to focus on the short term. In the short term, saving is all about establishing a rainy day fund or an emergency fund that you can easily dip into and withdraw cash if you ever need it. This can be a real lifesaver if you bump into unforeseen child expenses down the line.

On the other hand, investing is more about the long term. Investing should take into account your baby’s financial needs when they’ve stopped wearing diapers and started to do a bit of growing up.

The biggest difference between saving for a baby and investing for a baby is risk.

Infographic showing key differences between saving and investing
(Image Source)

When you save, you're normally going to be putting cash into a savings account like a money market account or Certificate of Deposit (CD). There's virtually no risk that you'll lose any of the funds you've saved — but these savings products aren't going to generate very big gains.

Meanwhile, when you invest, you have the potential for loss. A lot of investment vehicles are linked to the performance of securities like stocks, and there’s no guarantee that stock prices are going to increase. That means when you invest, there’s a risk that you’ll end up with less cash than when you started.

But there’s also potential that your investment pool will generate long-term gains and rewards. A lot of that boils down to compound interest.

There are some savings vehicles like CDs that do offer slightly higher interest rates than normal savings accounts — but generally speaking, if you want your money to work harder and generate more income from interest, you’re going to want to consider investing.

As a result of this, the choice between saving and investing for a baby will often depend on your timescale and your appetite for risk.

But because saving focuses on shorter-term needs and investment focuses on lifelong needs, ideally, you’ll want to develop a financial strategy for a baby that will let you both save and invest simultaneously.

What is a Good Savings Account for a Baby?

Generally speaking, savings products vary based on the provider — and the best account for your baby might not be the best account for the kids next door. That being said, most youth savings accounts have a few key features in common.

First and foremost, most bank or credit union accounts designed for kids are available for young people until they turn 21 years old. But some banks cap the age at either 12 or 18.

When shopping around for a savings account for a baby, you should be looking for an account with the highest possible interest rate. The best child accounts normally pay higher interest rates than adult accounts do — which is something banks do to incentivize saving from a younger age.

Illustration of girl placing coins into piggy bank

It’s also important to consider ownership.

A baby savings account will require custodianship, which means an adult will need to manage and make decisions about the assets in that account. That means you can open an account for a baby, but you, as the adult account holder, have full access and transactional authority over the account. As the child gets older, you can often opt for joint ownership instead.

So, what kind of savings account options do you have?

Banks tend to have their own types of regular deposit savings, money market savings, and certificate of deposit (CD) accounts you can set up for a child. Each account product will have its own pros and cons.

To find the best savings plan for your baby, you’ll need to assess key features like:

  • Annual percentage yield (APY)
  • Deposit rules
  • Monthly balance rules
  • Monthly fees
  • Matching programs
  • FDIC insurance

Rather than running from bank to bank trying to find the best savings account for a baby, it’s going to be a lot easier to look at the key features you’d like to have as part of your baby savings plan and then approach banks to find out if they can offer you a product that ticks all those boxes.

What’s the Best Investment Plan for a Child?

There are a number of investment vehicles you can use to build a nest egg for your baby — ranging from a 529 college savings fund plan designed to cover qualified education expenses to a trust fund that enables you to earmark assets to pass on to a child based on certain conditions.

But if you’re looking for a more flexible and tax-efficient option, one of your best bets is to set up a custodial account.

A UGMA custodial account is an investment vehicle that enables an adult to deposit and hold onto assets like stocks, bonds, or mutual funds on behalf of a child beneficiary.

Because a baby can’t make their own financial choices, the adult must serve as the account’s custodian until the child grows up and reaches the “age of majority” in their state. Generally speaking, that’s either 18 or 21 years old.

Illustration of woman and baby walking past rising chart

Unlike some other investment accounts, a UGMA custodial account has no annual contribution limits.

That means you, family, and friends can deposit as much cash or as many assets as you’d like into the account without running into contribution limits and getting penalized — and because everything in the account is the child’s legal property, there are also a couple of tax benefits including the “Kiddie Tax.”

The Kiddie Tax is an IRS rule that taxes any unearned income generated through a custodial account at the child’s lower tax code (up to a certain threshold). That represents a pretty big tax saving for most families. Likewise, you’re also going to benefit from the IRS Gift Tax.

The Gift Tax is an IRS levy on cash or assets that you give to someone or sell to them for way below market value. But you’re allowed a tax-free annual Gift Tax exemption of $16,000 per person per year (and a $12.06 million lifetime exemption).

That means you can gift $16,000 per year into your newborn’s custodial account without having to report that gift on your taxes. Past that limit, you can gift $12.06 million in your lifetime before having to pay taxes. A married couple’s limit is twice that amount.

Image depicting how the gift tax lifetime exclusion works
(Image Source)

If this sounds like something you’d like to explore, you should definitely check out EarlyBird.

EarlyBird makes setting up a UGMA account for a child fast and simple — but it also offers parents a variety of investment options. When you set up an account, you can choose between a range of exchange-traded fund (ETF) portfolios based on a number of factors that matter to you and your family.

Conclusion

Listen: having a baby is expensive — and those costs are only going to increase as a child gets older. Between saving for college tuition and big trips or trying to get onto the housing ladder, the children in your life are going to need money to fall back on when they grow up.

Fortunately, having a baby savings plan can help you prepare for those expenses and meet them head-on. But if you want to make sure that child is covered in the longer term, you have to consider investing, too. That’s where a custodial account comes to the rescue.

There's no cookie-cutter approach when it comes to investing for a baby. You need to consider what matters to you and what you think will be best for that child as they grow up. But if you're looking for a tax-efficient way to gift uncapped into a flexible investment vehicle, you should consider setting up a UGMA account through EarlyBird.


Ready to start investing for the child in your life? Download the EarlyBird app today.

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