Parents have a lot on their plate when raising a child. They fill a variety of roles, such as taxi driver, homework overseer and cheerleader. Some parents wait too long to consider one of the most important aspects of parenthood – saving for a child’s future. Starting this process early offers parents an opportunity to teach their child the value of money and how to manage it.
There are a variety of options when it comes to saving. Determining which method will provide the most benefit can be challenging. But rest assured, help is available. Speaking with a financial advisor is an easy way to find out about your options.
PNC Wealth Management Managing Director Joseph M. Jennings Jr. and Wealth Strategist Bryan Tracy offer information that can help parents begin thinking about saving for their child –- no matter the age.
Q. What accounts should parents consider opening for their child and at what age?
A. 529 Plan (College Savings Plan).
Age: as soon as possible.
Tax-deferred accounts where distributions are tax free if used for qualified educational expenses. The recently passed Tax Cuts and Jobs Act provides even more flexibility for 529 Plan accounts, allowing now for tax-free distributions of up to $10,000 per year for elementary and secondary schooling. Note, however, that these distributions may be taxable under state law.
Age: as soon as possible.
Savings accounts are federally insured to the maximum permitted by law and can help provide funds for long-term needs. By opening a savings account, parents can teach the concepts of earning interest and the power of compounding that interest over time.
Investment Account (Custodial account).
Investment accounts can be opened to teach children how to save for shortterm vs. long-term goals and the different investing options. Working with a financial provider that offers educational materials can help teach a child the concepts of risk tolerance, diversification, market volatility and financial markets. At a certain age, these accounts can be turned over and used for goals such as buying a house or car.
Age: 18 in most states. Credit Card applicants must meet the age of majority requirement for their state of residence.
Cosigning for a credit card can help teach your children the basics of responsibly managing credit and help them avoid potential pitfalls of using credit carelessly in college or early adulthood. It is recommend to start with a low-limit credit card and monitor the account activity.
Q. Are there tax implications for previous accounts you mentioned?
A. 529 Plan Account. Earnings grow tax deferred and distributions are tax free if used for qualified educational expenses. Depending on state law, there is potential for a state income tax deduction for the person who contributes to the account. The earnings are subject to penalty and ordinary income tax if not used for qualified educational expenses. And under some state laws, the use of these funds for K-12 education expenses may subject the tax benefits taken upon deposit to be subject to recapture.
Savings Account. Interest is taxed at an ordinary income tax rate as earned.
Investment Account. Interest and dividends on stocks and bonds are taxed at an ordinary income tax rate. There is potential for qualified dividends, which are taxed at a capital gains rate. The sale of assets is subject to capital gains tax. There also are potential gift-tax implications on certain transfers from parents to children on dollar amounts over the annual exclusion amount (currently $15,000 per individual per year, subject to adjustments for inflation).
Credit Card. None.
Q. As a child gets older, how should we teach them to save, manage and invest their savings?
A. Jennings says, “One great way to teach children about saving and managing money is to provide an allowance for household chores and activities around the house. A percentage of this allowance can then be used to save for short- and long-term goals. It is a good idea to set parameters with children for how much should be spent and how much should be saved. This helps teach the value of money and the importance of saving on a regular basis. As the dollar value of their savings increases, there will be more opportunities for children to learn about an emergency fund, stocks and bonds, risk tolerance, etc.”
Q. How can a child turn his/her savings into a wealth-building tool?
A. Tracy says, “Children can use their savings in the future to pay for specific needs, including an education, a down payment on a home or retirement. By starting early and realizing the power of compounding interest, they will be in a much better financial situation to use savings for short- and long-term goals. They will have the flexibility to make good financial decisions and avoid possible pitfalls that could derail their financial plan. Developing strong financial values and habits at a young age is the most important aspect of building wealth. Starting early will position them well for the future.”
Q. What are the pitfalls that should be avoided?
A. Both Jennings and Tracy caution that multiple credit card accounts with large credit limits should be avoided. A child should be careful when using credit and understand the implications of a poor credit score, which can have a negative impact on purchasing a home or car, future access to credit and good credit terms.
In addition, student loans can be a good option for paying for college, but a child must understand the potential longterm impact of student loans. They should have a clear understanding of future job prospects and earning potential to determine the financial obligations of taking on student debt.
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“As parents, we sometimes forget about what’s really important and that is saving for our children’s future,” says Joseph Jennings. “It’s never too early; the sooner the better helps them become financially prepared for the future.”
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1. Mississippi = 21, Alabama = 19, Nebraska = 19, All other states = 18
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