How to Save Money For Your Child's Future

April 5, 2021
investment strategy

When a new child comes into the world, all the people who love them start to dream of what their future will look like.

Parents and loved ones envision the child growing up, going off to college, going after their goals, and maybe even starting a family of their own. 

If you love a child, it’s natural to want to make a meaningful contribution to their successful future, especially since many of these goals cost money. 

The sooner people start saving and investing for a child’s future, the more time you have to help them build their savings. Plus, your investments can compound throughout the child’s life.

But, there are many ways to save money for kids, and you might be unsure about where to start. 

In this article, you’ll learn about the different savings options available to you and which can make the most meaningful difference in saving for a child’s future.

The Importance of Saving for Kids

One of the kindest things you can do for a child is to start saving for their future while they’re young.

A child’s early adulthood will be full of adventure and beginnings. They might head off to college, travel the world, start a business, move to a new city, or buy their first home.

By setting aside money through a child’s early years, you’re giving them options. When they reach adulthood, there isn’t just one path in front of them. With the money you’ve saved and invested for them, you’ve empowered them to create their own future.

Not only will those savings open many doors for that child, but you’ll be right there with them, connected by the meaningful gift you’ve given them.

How to Save Money for Kids

One of the best ways to save money for kids is through a custodial account. Let’s take a look at why that is:

What is a custodial account?

A custodial account (aka custodial brokerage account) is a type of investment account where families can save money for a child’s future.

A custodial account is opened by an adult in a child’s life — this adult is known as the custodian. The custodian manages the account through the child’s early years, including making all investment decisions.

Anyone can contribute to the child’s custodial account, and all contributions are irrevocable gifts. That means once you put money into the account, you can’t take it back out.

There are cases where custodians can withdraw money to use for the benefit of the child. But that can only be done in special circumstances, and not to pay for the basic costs associated with raising a child.

Assets within a custodial account legally belong to the child. Once they reach adulthood, they’ll take control of the account and can use it for any purpose.

The two types of custodial accounts are UGMA (Uniform Gifts to Minors Act) accounts and UTMA (Uniform Transfers to Minors Act) accounts. They differ only in the types of assets they can hold.

UGMA accounts can hold financial assets such as stocks, bonds, mutual funds, index funds, insurance policies, annuities, and cash. UTMA accounts can hold all the same financial assets, as well as physical assets, such as real estate and collectibles.

For most families, an UGMA account will meet all of their needs.

The true benefit of custodial accounts over any alternatives is flexibility. With an UGMA or UTMA account, you can save and invest throughout a child’s life. When they reach adulthood, they can use the money to fund any goal they wish.

More than any other type of account, custodial brokerage accounts empower young people to go after their goals and dreams with the financial support of their loved ones.

Custodial account vs. the alternatives

Custodial accounts aren’t the only way to save money for kids. But, with each of these alternatives, there are a few downsides to keep in mind.

Custodial account vs. savings account

A savings account probably seems like the simplest way to save for a child’s future. This option seems especially attractive to those who haven’t dipped their toes into investing before and for whom it seems too risky.

Unfortunately, you’re doing the child a great disservice by putting their savings into a simple bank savings account.

According to the Securities and Exchange Commission, the stock market sees an average annual return of 10% each year. 

A traditional savings account might have a rate return of just 0.05%. Even with a high-yield savings account, you’re lucky to find an option that pays more than 1.0% interest.

Here’s the problem with that: The Federal Reserve has a target annual inflation rate of 2.0%. If your money isn’t growing by at least that much, you aren’t just not earning money. You’re actually losing it.

And as the cost of things like higher education and houses increase, it’s important that the value of the child’s savings increase as well.

Custodial account vs. 529 plan

A 529 college savings plan is a tool specifically designed to help families pay for educational expenses. 529 plans come with certain tax benefits, which is why many families find them appealing. Unfortunately, there are some downsides to using this type of account.

529 plans are only designed to be used to save for college. As long as you use the money in the account to pay for education expenses, you can withdraw your earnings tax-free.

Unfortunately, 529 plans don’t allow any flexibility for someone wishing to use the money for any other purpose. If you use the money for non-qualified expenses, you’ll pay income taxes on your earnings, as well as a 10% penalty.

While many children go to college, it’s not for everyone. Those children who forge their own path will be punished with a 529 savings plan, as they then have to pay a penalty to use their own savings.

Custodial account vs. custodial IRA

A custodial individual retirement account (IRA) is a way to start saving for a child’s eventual retirement. If the child has earned income, you can contribute up to $6,000 as long as the child has earned at least that amount — outside parties can’t contribute more than the child earns in a year. 

Both the traditional IRA and Roth IRA come with excellent tax advantages, but it’s not the right choice for many people looking to save for a child's future. 

The reason for this is that the money in an IRA is meant for retirement savings. You may lose the tax advantages, and even pay a penalty, if money is withdrawn earlier.

And while saving for retirement is certainly important, a child will have many other big expenses that will come first.

Custodial account vs. parents’ brokerage account

Some parents get around the age limit on brokerage accounts by simply investing for their child in their own brokerage account. While this is an option, it might not make as much sense as using a custodial brokerage account.

First, any assets within an adult’s brokerage account are owned by that adult. While you might invest with the intention of gifting the money to a child in the future, they don’t really have any ownership over the funds.

Money in your brokerage account also doesn’t come with the same tax advantages as UGMA and UTMA accounts.

Why a custodial account with EarlyBird is the ideal solution

EarlyBird is an UGMA account where people can start saving for the future of a child that they love. You can have the account set up in minutes and begin investing money every month.

EarlyBird makes investing easy. You can choose from five different ETF portfolios ranging from conservative to aggressive. There is also an option to put up to 5% of a child’s portfolio into values-based funds that invest in companies that support causes near and dear to you.

An important element of EarlyBird is the ability for friends and family to invest collectively in a child’s future. Parents can send the link to loved ones, who can then contribute to the account in just a few minutes.

EarlyBird makes it easy for loved ones to share gifts that will have a meaningful impact on a child’s future.

Tips to Save For a Child

Are you ready to start investing in the future of a child that you love? Here are just a few extra tips to get you started.

Start early

When a new baby is born, opening an investment account for them probably isn’t the first thing on anyone’s mind. But the fact is that there’s no better time to start saving for a young child than at the start of their lives.

First, starting early gives you more time to save. 

Let’s say you have $100 of extra room in your monthly budget to save for the child’s future. If you start saving from the time they’re born, you’ll be able to stash away $21,600 by the time they turn 18 ($100/month x 12 months x 18 years).

Unfortunately, many don’t start saving until a child is just a year or two away from starting college or moving out on their own. In that case, you might only be able to save a couple of thousand dollars.

The other perk of starting early is that you give the money more time to grow.

When you put money into an investment account, you get to take advantage of compound interest and gains in the market. 

With compound interest, your money earns money, and then the money earned also begins to earn money. With stock market gains, the stock you’ve purchased increases in value over time. 

The bottom line is that the longer your money sits in the market, the more time it has to grow and compound.

Let’s go back to that $100 per month you saved during the child’s early years. If you put that money into a bank account with zero interest, you would have $21,600 after 18 years.

If you invested that money, you could have more than $57,000 when the child turns 18, based on the average annual stock market return of 10%

(Image Source)

You’re saving the same amount of money, but compound interest is working its magic.

Many people wouldn’t be able to save $57,000 in a child’s first 18 years. But by changing where that money is kept, you can more than double your cash investment.

Set up automatic contributions

It’s easy to say you’ll transfer money into a child’s investment account each month. But I think we all know that some months, things slip through the cracks.

A child’s future is too important to hope that you remember to save each month.

One of the best ways to make sure you save consistently is to set up automatic contributions to an investment account. Figure out how much you can afford to save each month, and then set up an automatic transfer from your bank account to the child’s investment account.

By automating your savings, you never have to worry about missing a month.

Invite friends and family to join

Other loved ones in a child’s life will surely want the opportunity to invest in their future. Often, they’ll default to gifting cash, but you can also invite them to contribute to the child’s investment account.

EarlyBird makes it easy for friends and family to come together and invest collectively in a child’s future. Loved ones can download the app and transfer money into a child’s account with just a few clicks.

EarlyBird also allows contributors to leave a short video message. These messages appear in a memories feed that the child can watch later. These memories will serve as a meaningful keepsake when that child reaches adulthood.

If you’ve already set up an EarlyBird account for a child, simply send friends and family an invitation to contribute.

By contributing to the child’s investment account rather than simply giving cash, family and friends can make a meaningful impact on a child’s future, helping them to achieve their goals and dreams.

Use it as an opportunity to teach a child about finances

Saving money for a child you love is an important way to prepare for their future, but it could also be an opportunity to teach them about money management.

Saving for the future is important, and most families aren’t saving enough. By talking to children about the money you save for them, you can educate them about the importance of saving.

You can also discuss with them the basics about how their investment account — and the stock market overall — works. They’ll leave home and start their adult lives with a better understanding of finances than most of their peers.

Not only will the child gain a greater understanding of finances, they’ll also become engaged with the process.

As you save for the future of a child that you love, you can talk to them about the money in the account and encourage them to dream big with it. 

As a result, they’ll feel a sense of ownership over the funds in the account. The older that child gets, the more excited they’ll be to start planning their future.

Involving them in investment decisions for their custodial account also helps to impart important values.

When you use EarlyBird, you can allocate a portion of a child’s portfolio to values-based funds. You can invest in companies that support causes that are important to you, such as environmental protection, diversity, and female leadership.

So, not only will the child learn the importance of saving, they’ll learn the importance of investing in causes that are important to them.

Know the tax laws

If you’re going to be saving money for a child that you love, it’s essential that you understand the tax ramifications of whatever type of account you open.

When you earn money in an investment account, you’ll usually have to pay taxes on any earnings. Luckily, custodial brokerage accounts come with some tax advantages.

Any earnings in a child’s UGMA account are considered that child’s unearned income and are taxed as such. The first $1,100 of earnings are tax-free. The next $1,100 is taxed at the child’s tax rate, which is usually lower than yours.

It’s not until a child’s account has earned more than $2,200 in a year that returns will be taxed at your tax rate.

If you have an investment account for a child, it’s important that you report these earnings to the IRS. If you’re not sure how to properly include this in your tax return, then a tax professional can help you file your taxes and report these earnings.

Whatever you do, don’t let your fear of the tax code stop you from investing for a child. The amount the child’s account can grow by easily outweighs any amount you may end up paying in taxes if invested and recorded properly.

Conclusion 

There are so many decisions to make when it comes to enriching the life of a child that you love, including the method through which you’ll save for that child’s future. 

Starting when a child is young can help you save more and give your money time to compound. And, more importantly, you’ll give that child the gift of financial literacy, which they’ll carry with them through their entire lives.

Whether a child hopes to go to college, travel the world, or start a business, a custodial account can help you to save and prepare that child. EarlyBird makes it easy for loved ones to collectively invest in a child’s future.

Download EarlyBird on the app store today to start investing in the kids you love.

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