The arrival of a newborn is a momentous occasion for parents that often prompts them to consider their child’s financial future. While it might seem far away, they realize large expenses may come as the child reaches adulthood, including college, a house and a wedding, to name a few. To help with these expenses, parents often consider a savings plan for their newborn that will grow and help with these future costs.
There are a few different ways a parent can go about saving for their child, each with pros and cons. A few of the options include 529 plans, UTMA accounts, brokerage accounts and savings accounts.
529 plans
A 529 plan is a college savings account that offers tax benefits and allows the contributions to be invested into available stock and bond funds. While contributions do not get a federal tax break, earnings inside the 529 are tax-deferred and tax-free if used for qualified education expenses. In most states, a tax deduction on state taxes is available on contributions up to certain limits. Since 529s are administered by each state, the investment selections are limited to approved funds and may result in some states having less attractive investment options than other states.
Qualified education expenses include tuition, fees, books, computers and room and board for students who are at least half time (typically at least six credits per semester). Federal tax and a 10% penalty on earnings are due if 529 funds are not used for education costs.
A common concern for many regarding 529 accounts is the possibility that their child might not need college funding, either by not going to college or getting a full-ride scholarship, but 529s have a lot of features to reduce this concern. The account can be used to pay for community college, trade schools and certification programs. Up to $10,000 can be used for K-12 costs at a private school, and another $10,000 can be used to pay off student loans.
In addition, the beneficiary of the account can be changed to a broad range of relatives, including siblings, parents, cousins and even future generations, to name a few. If the child ends up getting a scholarship, the amount of the scholarship can be withdrawn penalty-free from the 529, with no limitations on how it is spent and with only taxes on those earnings due. 529s that have been opened for 15 years can also be rolled over to a Roth IRA owned by the child, up to $35,000 in a lifetime, as long as each rollover amount is counted as the child’s Roth IRA contribution for that year.
UTMA accounts
An UTMA (Uniform Transfers to Minor Act) is a custodial account that allows an adult to manage investments on behalf of a minor. Investment options are vast, including stocks, bonds, mutual funds, ETFs and more.
While the adult manages the account for the minor and chooses investments, it’s important to know that funds placed inside this account are owned by the child. While there is no penalty for withdrawals, money must be used for the benefit of the child. Once the child reaches the age of majority, age 18-25 depending on the state of residence, the account is turned over to them to control however they like.
Investments inside the UTMA may produce income and capital gains. An important advantage of the UTMA account is how these investment gains are taxed. In 2024, the first $1,300 of income and gains are tax-free to the child. The next $1,300 is taxed at the child’s rate, which is usually lower than the parent’s rate. Any income or gains above $2,600 for the year are taxed at the parent’s rate.
In certain situations, it may be beneficial for a parent to gift stock to a child via an UTMA account and have gains and income taxed at the child’s rate.
Brokerage accounts
If the thought of the child having full control of the account causes concern, a brokerage account may be a good option. In this instance, the parents would open a brokerage account in their name and direct contributions and investments however they like. They can save and invest funds for the child but are under no obligation to ever give them the funds.
As the child enters adulthood, the parents can then gift the investments to their child while being mindful of the annual gift tax exclusion ($18,000 in 2024) or name the child as beneficiary of the account.
The brokerage account has a wide array of investments, similar to the UTMA account. Since the parents are owners of the account, all income and gains would be taxed at their rates. While that is a disadvantage to the UTMA, the brokerage account has the advantage of giving the parents more control over the funds. As stated, the funds are not required to be given to the child at adulthood.
Withdrawals do not have to be made for the benefit of the child, but instead can be used in any way the parents choose. The account can be established with the full intent of helping the child later in life, but also be used by the parents if times get tough financially.
Savings accounts
A savings account can be a good option for parents looking to save money for their kids, especially for money that they do not want exposed to the stock market. An adult would need to be either primary or joint on the account with the child. The funds can be invested in a high-yield savings account or CD, away from daily investment market fluctuations. Also, money up to $250,000 is FDIC-insured.
When it comes to saving money for a newborn, parents have a few options to consider. They each have unique features that may make one more appealing than the others depending on the parents’ situation and financial goals.
Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS. Kehoe Financial Advisors is not affiliated with Kestra IS or Kestra AS. Investor Disclosures: www.kestrafinancial.com/disclosures
