Saving for your child’s future: What should you consider?

November 26, 2020
Jeff Witz, CFP

529 plans and trusts help save and manage money destined for your children.

What are the best options to save for my child’s future?

Whether it’s for a college education, a down payment on a house, a future wedding, or just giving them a little leg up once they reach adulthood, saving for a child’s future is an important goal for many physicians. With costs rising across the board, many physicians wonder what is the best way to save. The answer, as with many things, depends. Parents should ask themselves: Do I want this money to go toward a specific goal? Do I want my children to have access to the funds all at once? Will my child manage this money responsibly? The answers to these questions can determine what type of account is best.

A common goal for many parents is to start saving early for their children’s college educations. With the rising cost of college, this can seem like a daunting task. The Internal Revenue Service allows those who wish to save, the ability to contribute to a 529 plan. A 529 account is an investment account that provides favorable tax treatments if the money is used for qualified education expenses such as tuition, room and board, equipment, student loan payments, and apprenticeships.

Money contributed to a 529 plan can be invested in various mutual funds. These investments will (hopefully) grow as the child does. If withdrawals are taken to pay for a qualified education expense, the balance including the investment gain comes out of the account tax free. In addition, some states give a state income tax deduction for contributing to a 529 account, so there may be additional tax incentives for contributing.

However, if money is withdrawn from the account for a nonqualified reason, the account owner will need to include the investment gain in their income and pay ordinary income tax. In addition, nonqualified distributions are subject to a 10% penalty. Withdrawing money from a 529 for a nonqualified purpose can be very costly, but if used for to pay for education expenses, it can be a very useful savings tool.

What if your goal is to save for a down payment on a home, pay for a wedding, or simply give your child a financial head start?

First determine the level of control you want to retain over the account and its ultimate use. Parents who have a specific purpose in mind or are unsure their child will be responsible enough to manage the money in a sensible way, will want to make sure they or someone else controls how the money can be distributed.

There are 2 primary ways to accomplish this. The first is to keep the money yourself. You control the assets and their distribution. However, depending on your estate planning goals, this may not distribute the assets as intended in the event of your death.

The other option is to create a trust. Establishing a trust fund creates a vehicle that sets terms for the way assets are to be held, gathered, or distributed in the future. Common reasons for distribution often include health, education, maintenance, and support (HEMS), but can expand beyond these. The definitions of HEMS or other allowed distributions can be as strict or relaxed as you choose.

Most trusts also create a timeline for when the beneficiary can access a greater portion or the full balance of the assets. Creating a trust ensures the assets are controlled until the recipient is deemed old enough or responsible enough to take over the money themselves.

If control is not a primary motivation, then custodial accounts can be opened. Commonly referred to as UTMA (Uniform Transfers to Minors Act) accounts, custodial accounts have lots of flexibility in terms of the assets that can be held. However, once the minor reaches the legal age of adulthood in their state of residence, control of the account officially transfers to the named beneficiary, and they claim full use of the funds.

There are many ways to save for your child’s future, but the intent and the level of control you want to maintain will determine which account type is best.

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