Financing the Future: Setting Up Savings Plans for Grandchildren
Before most students graduate high school, many will have earned a basic understanding of various subjects. Most courses are equipped to provide students with a basic knowledge of overall concepts relating to calculus, English literature and chemistry. However, some topics are rarely covered in class, despite their increasing importance after graduation. Financial literacy, including topics surrounding retirement and taxes, is one of those topics that students aren’t really taught in school — but it’s also one of those topics that can be vital to kids’ ability to live comfortably and thrive as they navigate adulthood.
With this in mind, one of the best gifts grandparents can give to their grandchildren is a strong foundation in financial knowledge — or even some financial security for the future. If you’re thinking about getting your grandchild set up with financial tools that’ll help safeguard their future — or teaching valuable lessons using various tools — these financial products are ideal places to start.
Regular Savings Accounts
It’s almost never too early to start teaching children about financial literacy and the importance of saving, and managing finances is a lesson that can carry a child through adulthood. Although you can open a savings account and start funding it as soon as your grandchild is born, it’s also appropriate to start teaching kids about saving when they’re around elementary school age. At this stage, they can understand the basic math concepts needed to manage a savings account (with help, of course), and this is also the stage when they might begin earning an allowance or receiving birthday money they want to save.
Many credit unions and banks offer specialized savings accounts for children. You can open the account in your grandchild’s name, which they can often access once they reach age 13. There are a few important factors to keep in mind when selecting this kind of savings account, however.
Different financial institutions offer different interest rates. It's important to look around for a bank that offers the highest interest rate and, therefore, the highest return on deposits. Another thing to keep in mind is that some states have implemented laws to regulate bank accounts for minors. Check with your chosen financial institution on related laws before opening an account.
One final decision you’ll need to make is if you want to choose a regular savings account or a Uniform Gift to Minors (UGMA) account and serve as its custodian. There will be additional factors to consider besides annual percentage rates and regulatory policies.
Uniform Gift to Minors Act Accounts
A Uniform Gift to Minors Act (UGMA) account is also known as a custodial account. A regular savings account gives the guardian and child joint ownership over the account. With a UGMA account, your grandchild is the sole owner of the assets and will be able to access all funds once they reach the age of majority in your state, while you can monitor activity on the account.
One big difference between UGMA accounts and traditional savings accounts is that you can open one of these accounts at a bank or at a brokerage firm. This is because the UGMA account doesn’t only hold monetary deposits that generate interest payments. You can also buy stocks, bonds, mutual funds and similar types of securities on your grandchild’s behalf using this type of account. As the account’s custodian, it’s your responsibility to manage the assets within it in a way that serves your grandchild’s best interest.
The money is treated as a gifted asset in the UGMA custodial account. This means your grandchild fully owns all the assets in it. It's important to note that the IRS places some tax burdens on these custodial accounts.
There’s another similar type of account called a Uniform Transfer to Minors Act (UTMA) account. It’s similar to the UGMA in how it functions, but you aren’t limited to adding financial products like stocks and bonds to it. You can also add assets like real estate or even cars to UTMA accounts. However, keep in mind that, while all states recognize UGMA accounts, some states do not allow you to open UTMA accounts. You may prefer to contact an attorney to learn more about the options available where you live.
Other Investment Accounts
If your grandchild is old enough to join the workforce and they’ve had a job at which they earned enough income to be required to file taxes, another option for them is to open an individual retirement account (IRA). With your help opening the account, the IRA allows your grandchild to save money for the long term: their retirement.
Contributions to the account are tax advantaged; with a traditional IRA, they won’t pay taxes on the money they deposit until they withdraw it in retirement. Talk to your chosen financial institution about which type of IRA is most beneficial, as there are several to consider.
529 Education Plans
Many people build savings accounts for emergencies, while others plan for long-term events like retirement. One of these big — but happening a bit earlier than retirement — events is your grandchild’s decision to go to college. The cost of attendance, including tuition, books, and room and board, continues to rise each year. Although student loans are typically available for the average high school graduate, the debt accrued post-graduation can be daunting. That’s why it’s important to consider saving for future educational aspirations with a 529 education plan.
According to the Securities and Exchange Commission, a 529 plan "is a tax-advantaged savings plan designed to encourage saving for future education costs." Legally referred to as "qualified tuition plans," these accounts are sponsored by state agencies or schools and come in two types. Prepaid tuition plans "let a saver or account holder purchase units or credits at participating colleges and universities (usually public and in-state) for future tuition and mandatory fees at current prices for the beneficiary." Education savings plans "let a saver open an investment account to save for the beneficiary’s future qualified higher education expenses – tuition, mandatory fees and room and board."
There are certain fees and expenses involved with a 529 plan that vary depending on the plan and whether a broker sells it or not. Completely and carefully review all the terms of the plan to gain a full understanding of these investment options.
What Should You Choose First?
Like any financial decision, choosing the type of account to use can also depend on your grandchild's goals — or the aspirations you help them figure out. Take some time to sit down with your grandchild and introduce the concept of a savings account if you feel they’re ready. Although many kids may not know where they want to attend college or when they want to retire, saving money is essential for everyone.
It may be a good idea to open a simple savings account initially. From there, your grandchild can witness the benefits of interest and see how their money grows over time. Giving your grandchild the gift of financial literacy is a lesson that they’ll carry until it's their time to spread this monetary message — and long after that.