When you’re spending heavily to cover your kids’ present needs – from diapers to clothing to music lessons – it's easy to lose sight of saving for their future needs. Yet there’s a huge benefit to doing so, since the sooner you start to invest for them, the more time those investments have to grow. Thankfully, a number of tax-advantaged vehicle are available to help encourage you to put aside for your child’s education and other requirements down the road.
1. College Savings Plans
Section 529 of the income tax code established tax-advantaged savings plans and prepaid tuition plans that offer a wide range of benefits for you and your child. These plans allow new parents (or grandparents) to set aside money for higher-education costs at either a public or private university. When it comes time for college, your child will be entitled to withdraw the principal, and the earnings, from the account tax-free. While you cannot deduct contributions from your federal income taxes, you can do so for any state income taxes you pay.
As the donor, you remain in control of the account. That includes being able to roll over the funds to another child should the original beneficiary not attend college for any reason.
Prepaid tuition programs allow residents to prepay the cost of your child’s tuition at state colleges. This allows you to make those payments early, and avoid the possibility of a downturn in the stock market--and, it should be noted, from benefitting should the market grown healthily. More importantly, it allows you to pay state tuition at the current rates, and be insulated from tuition hikes in future. Many prepaid tuition programs, too, allow you to change the beneficiary so if your child receives a scholarship or becomes disabled, you can give the funds to another loved one.
2. Roth IRAs
It might seem odd to think about saving for your child’s retirement when your kid is just learning to drive, but there is a good reason to be proactive. Early investment not only allows for decades of compounding before your teen reaches retirement, but allows a very favorable tax treatment through a Roth IRA.
With these vehicles, unlike with independent IRAs or 401(k) plans through your employer, tax is paid when funds are contributed to the plan, and are then sheltered when you withdraw from them. If your child earns up to $5,500 a year--from, say a part-time job--the funds can be contributed to a Roth IRA in his or her name. The tax rate, too, is based on their (usually low) earnings, and so offers a very favorable way to make a long-term investment in their future retirement.
3. UTMA Accounts
UTMA refers to the Uniform Transfers to Minor Act. UTMA accounts allow you to gift your child stock, real estate, or other assets, with any taxes also calculated at the child’s rate. These accounts offer more flexibility than other tax-advantaged savings programs.
However, a UTMA has a noticeable drawback. Once your child becomes an adult, he or she completely owns the account. A responsible adult will use the assets will use the funds responsibly--say, to pay for higher education expenses--but an irresponsible one may not do so. The flexibility of these accounts, then, means that you forfeit control over how your child-turned-adult chooses to spend the money.
Teaching Values with Savings
As a mom or dad, you want your child to have a secure future. 529 plans, Roth IRAs, and UTMA accounts are three ways a middle-class parent can set aside money for big ticket expenses like college or retirement. All of these plans offer real tax benefits to your child.
In addition to passing on financial resources, you want to impart certain values on your children. A child that sees mom and dad setting aside money in a 529 plan sees that education and savings are important. After all, you want your children to model your best behavior so you should teach them the value of saving by starting to save today.
This story originally appeared on ValuePenguin.