First Steps for Your Baby's Financial Future

January 5, 2011

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's the best use 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,

How fortunate your baby is to have a mom who, in the midst of all the daily responsibilities of being a new parent, is also thinking about the future. This is a great question for the New Year, and as a parent myself, I can tell you that the future comes all too quickly! It's great that you already have some savings. And hopefully you've made saving a financial habit. 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 completely depends on how you expect to use it. Let's look at different goals and how you could plan for each.

If college is your main goal
When it comes to keeping up with the increasing cost of higher education, a tax-advantaged college saving account such as a 529 Plan is probably your best choice. This is a state-sponsored program that allows parents, relatives and friends to invest for a child's college education—making it easy for grandparents to chip in, too. The account belongs to you, not your child, and you remain in control of the money. Usually you have a choice of investment portfolios that are professionally managed, so it doesn't require a lot of work on your part. Potential earnings grow tax-deferred. And you pay no federal taxes on earnings as long as you withdraw the money to pay for qualified higher education expenses such as tuition, books, room and board. (If your child doesn’t go to college after all, you can either transfer the account to another qualified family member or elect to pay the tax and a 10% penalty to withdraw the funds.)

Minimums for opening a 529 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 (for your convenience, most financial institutions offer a 529 Plan). Plus, you can set up an automatic investment plan—say $50 or $100 a month—making it easy for you to keep contributing.

Beyond college saving
College may not be the only opportunity you want to provide for your daughter. To save for things beyond qualified college expenses—say for music lessons or private school tuition—you could open a custodial account. This is a brokerage account managed by a parent or guardian on a child's behalf. Custodial accounts offer minor tax advantages and have 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, CDs—according to your feelings about risk. Another key difference is that the child takes control of the money at the "age of majority"—18, 21 or 25 depending on state rules and your instructions. The plus is that if your daughter doesn't go to college, the money could be used for a variety of things—another type of schooling, a business venture, or a down payment on a home. The minus is that she could spend it frivolously.

Another option is to open a regular brokerage account in your own name and earmark savings and investments for your daughter. That would give you the control and freedom to use the money as you see fit. However, if the money is in your name, you’re also responsible for the tax bill. Keep that in mind as you make your decision.

Other options
You mention CDs and Savings Bonds, and while these are of course possibilities, with today's low interest rates, they wouldn't be my first recommendation. For long-term savings, I think you could do better with the variety of investments available in one of the other accounts, both in terms of taxes and potential earnings over time.

Here's what I suggest right now. Assuming that college is your number one goal, put the money you currently have saved in a college savings account and commit to adding more to this account each month. There are a number of online calculators that can help you determine a realistic monthly savings goal. (According to the College Board, projected college costs in 2028 range from $257,113 for four years at an in-state university to $524,579 for four years at a private college.)

If you're able to save more, consider a brokerage account or even a high-yield savings account to handle other types of expenses. And as your daughter gets older, be sure to involve her in the process. It's a great opportunity to get her into the savings habit, teach her how money can grow, 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.

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, Financial Planner or Investment Manager. The type of securities and investment strategies mentioned may not be suitable for everyone. Each investor needs to review a security transaction and investment strategy for his or her own particular situation. Data contained here is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

As with any investment, it's possible to lose money by investing in a 529 plan. Additionally, by investing in a 529 plan outside of your state, you may lose tax benefits offered by your own state's plan.


The information on this website is for educational purposes only. It is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, consult with a qualified tax advisor, CPA, financial planner or investment manager.


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