Please welcome my friend Matt Becker, founder of Mom and Dad Money, who is dedicated to helping new parents build happy families by making money simple.
My wife and I are incredibly lucky to have two awesome sons. Our oldest just turned 2 and our youngest is now 3 months old. Both of those numbers feel a little crazy when I type them out. How are they already so old?
We’re also lucky to have incredibly generous family members, particularly grandparents, who like to give our kids cash for birthdays and holidays.
When they get older, any gift money they receive will be theirs, plain and simple. But right now, the reality is that our kids aren’t ready to be given this money directly. Our oldest would probably try to eat it and our youngest would definitely spit up on it. Not exactly the best use of their grandparents’ hard earned cash.
So what do we do with this money? It’s an interesting question that has both a financial and a philosophical spin to it, and to be honest it’s one that we haven’t totally figured out our own answer to. So today I’d like to talk about 3 options we’ve considered for what to do with our kid’s gift money, and I’d love to hear your opinions in the comments. Hopefully we can all learn from each other.
Option #1: Start a college savings fund
I have to say, this is a really enticing option. And it’s actually the one my wife and I have been using for each of our kids so far.
See, we care about our kids having the option of higher education. It’s important to us. But college is also CRAZY expensive, and with all of the other financial responsibilities a new parent has it can be really hard to find extra room in the budget for substantial college savings.
Which makes gift money feel like such a blessing. We can use it to help them get a jump-start on college without sacrificing our other important saving goals. It’s a win-win!
But there’s a potential problem with this route.
Two of the most popular ways to save specifically for college are a 529 plan and a Coverdell ESA. Both of these are great options and work a lot like a Roth IRA, just for college instead of retirement. All of the money in the account is allowed to grow tax-free, and as long as the money is spent on qualified education expenses then all distributions are tax-free too. There are differences between the two types of accounts, and you can see a quick comparison chart here.
The problem is that the money in those accounts is only tax-free if used for qualified education expenses. If it’s withdrawn for any other purpose, there are not only taxes but a 10% penalty on the earnings (there are some exceptions for scholarships and the like).
What that means is that you’re essentially taking your kids’ money and telling them they HAVE to use it for college. This isn’t necessarily a bad thing. As parents we make decisions about what’s best for our kids all the time and there’s no inherent reason to treat this any differently.
Still, some people don’t like the idea of choosing what to do with money that was given directly to their kids. So there are some other options to consider.
Option #2: Put it in a regular old savings account
Other than stashing the money away in a piggy bank (also a viable option), this is probably the best route if you want your child to be able to have control over the money as soon as possible. You can’t open an account solely in their name, but you can put both your name and the child’s name on the account. Then, when they’re old enough, you can give them access to the account so that they can use the money as they please.
The money won’t earn a ton of interest, though an online bank will at least give you something. But earning interest isn’t really the point here. The big advantage to this option is that you’re keeping the money safe until you can eventually leave it in your child’s hands to make their own decisions.
Option #3: What if you want to invest?
Let’s say you want to invest the money but don’t want it tied up until college. The problem there is that minors can’t own things like stocks, bonds and mutual funds, so you can’t open an investment account in their name.
The simplest solution here would be to open up a new investment account in your own name. You would make all the decisions now, and then when your child is old enough you can let him or her help you out. This could actually be a really cool way to help them learn the basics of investing.
A slightly more complicated route, but one that more truly preserves the ideal of that gift money being the child’s, is to open what’s called a custodial account. This is an account where the money is legally held ìfor the benefit ofî the child, but someone (often you) is named as the custodian to make decisions about what to do with the money until the child turns 18 (sometimes older). These are called UGMA or UTMA accounts and you can open these at any of the big investment firms. You can also open them at banks, but that probably isn’t the best option if you’re looking to invest.
There are PLENTY of things to consider before opening a custodial account that I won’t get into here, and it’s probably best to speak to a professional (accountant or financial planner) before doing so. But it could be a nice option if you want to invest the money AND preserve the child’s ownership.
So what do you think?
Like I said above, my wife and I have been putting all gift money for our sons into college accounts. We’re comfortable with that approach, but I have to say that a part of me agrees with the opinion that it’s our kids’ money and they should (eventually) have full say about what they do with it.
What do you do with your kids’ gift money? Maybe you’ve got an interesting approach I haven’t considered yet. Do you have any strong opinions about whether the child should have final say in how the money is used? I’d love to hear your thoughts!
Editor’s note: A huge thanks to Matt for the awesome support, advice, and of course great content. 🙂