Morgan Stanley
  • Wealth Management
  • Jun 17, 2021

How to Save for Your Child’s Future

Whether you’re saving up for your child’s education or a monetary gift they’ll receive in young adulthood, it’s never too early to start.

We all want the best for our children. That means different things in different families, but most of us aim to instill good values, provide basic comforts (and some extras!), and set a solid foundation for the future. That often includes establishing a strong financial foundation.

Parents who start saving and investing for their children early can take advantage of the power of compounding, or earning interest on interest and returns on returns. Thanks to this effect, even small contributions may grow significantly over time.

Not sure how to start saving for your child’s future? Let’s go over some strategies and specialized accounts designed to help you plan for education costs, monetary gifts, and expenses for children with disabilities.

Introducing Good Financial Habits

Children come into money in various ways—an allowance, gifts from Grandma, or part-time jobs when they’re old enough. You can teach them responsibility and introduce habits they’ll carry into adulthood by guiding them through specific behaviors: saving for a specific goal, like a large purchase; giving to charity; or even investing in the stock market through a custodial brokerage account. In addition to your savings efforts, these actions can help your child take a stake in their own financial future.

529 Education Savings Plans

529 plans offer flexibility and potential tax benefits when saving for school. Money in these accounts grows tax-deferred, and withdrawals are free from federal tax as long as they’re used for qualified education expenses, which include tuition, fees, room and board, books, supplies, computers, and other required technology services, such as Internet access. Contributions qualify for the $15,000 annual gift tax exclusion,1 and in some states, may even qualify for a state income tax deduction.

529 plans feature high lifetime contribution limits, which may be upwards of $200,000 depending on which state’s plan you’re using. This could allow account holders to accumulate enough assets to cover tuition costs fully, in many cases. Plus, you can use up to $10,000 per year of plan proceeds to cover private elementary or secondary school tuition.2

Keep in mind, distributions used to pay for anything other than qualified education expenses might be subject to state and federal income taxes and a 10% tax penalty.

Coverdell Education Savings Accounts (ESAs)

Funds invested in Coverdell ESAs grow tax-free, and they can be used to cover a variety of education-related expenses, including tuition, room and board, books, and other supplies, such as computers or calculators. However, age, income, and contribution limits make these less flexible than 529 plans.

In addition, contributions may not exceed $2,000 a year, and you must make less than $110,000 a year ($220,000 if filing a joint return) in household income to qualify.3 Moreover, the account must be established before the beneficiary reaches 18 years of age, and the funds must be used by age 30.

Uniform Transfers to Minors Act (UTMA)/Uniform Gifts to Minors Act (UGMA) Accounts

If you have investable assets such as stocks, bonds, annuities, or cash that you’d like to reserve for your child, another option is putting them in a custodial account under the UTMA/UGMA. The money is an irrevocable gift (i.e., you can’t take it back), and you control the account as the custodian until the minor beneficiary reaches adulthood.

Money in a custodial account doesn’t have to be used on education-related expenses, allowing children to use funds for other needs or goals, such as taking a gap year before college or buying a home later in life.  You can suggest how your child uses the savings, but be prepared that their decisions about it may differ from your preferences.

Another watch-out: Saving in a UTMA or UGMA account might affect a child’s ability to qualify for need-based financial aid. If you are considering one of these accounts, it can be a good idea to talk to a Financial Advisor about the opportunities and limitations.

Achieving a Better Life Experience (ABLE) Accounts

An ABLE Account is a vehicle to grow savings for a child with disabilities. Typically, an individual must have less than $2,000 in assets to qualify for Supplemental Security Income (SSI) through Social Security. One of an ABLE Account’s key benefits is that the money inside it generally does not affect the beneficiary’s ability to qualify for this kind of public assistance,4 as long as the balance stays below $100,000.5

The ABLE Account offers a tax-free way to save for qualified disability-related expenses, such as education, housing, transportation, employment training, health care, and legal fees. You can contribute up to the annual gift exemption limit, which is $15,000 for 2021.

Next Steps

A financial head start in life is one of the best gifts a parent can give. There are many ways to set your child up to become a financially responsible adult—and to put money away for their future. If you need help getting started, consider talking to a Financial Advisor about your options and which ones might be a good fit for your family’s needs.