Personal Finance | March 9, 2016

First Steps for Your Baby's Financial Future

Key Points

  • New parents should start early to plan for their child's financial future.

  • A 529 plan is a smart way to get a head start on college savings.

  • Diversifying with other types of accounts and developing a saving plan will help cover other expenses as your child is growing up.

Dear Carrie,

I've just had a baby! Things are pretty crazy in my house right now, but I want to be sure I give my daughter every opportunity I can. I have a little bit of money saved up, but I'm uncertain what the best use is for it. Should I buy a savings bond, a CD, open an investment account or put it all in a college fund?

—A Reader

Dear Reader,

First, congratulations to both you and your daughter. I'd say she's pretty fortunate to have a mother who, in the midst of all the new baby responsibilities, is already thinking about the future. As a parent myself, I can tell you that the future—and all the related expenses—comes all too quickly!

Being ready for those expenses goes hand-in-hand with smart saving habits, so it's great that you've already begun. Whatever the future holds, continuing to save will be the cornerstone of providing a solid financial foundation for your daughter.

In terms of what to do with the money you've already saved, that depends on how you expect to use it. While college is often a primary goal, there will be a number of interim financial goals that you'll want to meet as your daughter grows up. Let's look at how you might plan for each.

Consider a 529 account for college saving

When it comes to planning for higher education, a tax-advantaged college savings account such as a 529 Plan is often the best choice. This is a state-sponsored program that lets parents, relatives and friends invest for a child's college education. The account belongs to you, not your child, and you remain in control of the money.

Usually you have a choice of professionally managed investment portfolios. Potential earnings grow tax-deferred. And you pay no federal taxes on earnings as long as you use the money for qualified higher education expenses such as tuition, books, and room and board.

Opening minimums vary by state, but can be as low as $25. You're not limited to your own state's 529, so you're free to shop around at different financial institutions (though you should first consider any state tax benefits your own state’s plan may offer). Plus, you can set up automatic contributions—say $50 or $100 a month—making it easy to keep saving.

If grandparents want to help, gift tax rules make it easy for them to contribute larger amounts. This can benefit their estate planning as well as your college planning.

Designate different accounts for other needs

While a college account may be at the top of your list, there will be other opportunities—say music lessons or private schools—that you want to provide your daughter along the way. To save for these eventualities, consider a couple of other types of accounts.

  • Custodial brokerage account—This is a brokerage account managed by a parent or guardian on a child's behalf. It offers minor tax advantages and has minimal restrictions on how the money can be spent as long as it's for the benefit of the child beyond daily living expenses. Unlike a 529, there are no recommended investment portfolios. You can choose from a wide variety of investments—stocks, bonds, mutual funds—according to your feelings about risk. A key difference is that the child takes control of the money at the "age of majority," which is 18, 21 or 25 depending on state rules. That's something to think about.
  • Regular brokerage account—This is a taxable account that you could open in your own name and earmark the savings and investments for your daughter. You'd then have the control and freedom to use the money as you see fit.
  • Passbook savings account—This could be for short-term savings needs. It's also an account your daughter could contribute to, as she gets older.

As for investments, equities generally have the greatest potential for long-term growth.  Realize, though, that because stocks are volatile, they should be reserved for goals beyond a 3-5 year time frame.  For shorter-term goals, CDs and Savings Bonds are safer; the downside is that they carry very low interest rates.

Create a plan

If you have a savings plan, putting money aside will be easier, so here's what I suggest right now. Assuming college is your first goal, put the money you currently have saved in a college savings account and commit to adding more each month. There are a number of online calculators to help you determine a realistic monthly savings goal.

As you're able to save more, consider a brokerage account or passbook savings account for other types of expenses. Once you know your monthly college savings goal, you might also establish a monthly savings goal for this account and put it on automatic.

Don't forget your daughter's financial education

As your daughter gets older, be sure to involve her in the process. Help her create her own savings goals and have her save a portion of any money she gets. This will get her into the savings habit early, teach her how money grows, and help her make good spending decisions. Because no matter how much you save for your child, teaching her to be financially independent is really the greatest opportunity you can give her.

Have a personal finance question? Email us at Carrie cannot respond to questions directly, but your topic may be considered for a future article. For Schwab account questions and general inquiries contact Schwab.

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