Most parents feel like they should open up a savings account as soon as their kids receive their first birthday or holiday check. But for most people, that’s not the best approach. Most of the time, savings account balances hover around the same amount for years, and the bank pays very little interest (the average of the top five banks ).
So, what should you do instead? Follow the steps below to determine what is right for your family.
Step 1: Get your own financial life in order.
Before you do anything, make sure you can practice what you preach. Do you have a good handle on your own finances so that you can calmly and positively discuss money with your kids?
If yes, read on. If no, get yourself organized first. Create a budget, consolidate old accounts so that you know where everything is, and have an action plan for saving for your goals.
Step 2: Decide on the intent for saving for your kids.
Is the goal to teach your children about saving and the value of money? Or do you want to start setting aside money for college? You can do both, but they involve different types of accounts.
For college savings, a traditional savings account may not cut it. You need an account with growth potential, and one of the the better ways to achieve growth is tax-free through a 529 College Savings Plan. You can pick a plan in any state and use it for any qualified education expenses (think room, board, and tuition) nationwide and with a lot of international programs.
There are over 80 plans on the market, and savingforcollege.com is an excellent resource for comparing them.
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To take the most advantage of growth and the power of compounding, start saving early and invest in an aggressive growth index portfolio (if offered in the plan you choose), which, while not without risk, tends to have the lowest expenses and the greatest growth potential.
If your goal is to teach your kids about money, you’ll want to actively involve them throughout the process. Rather than doing it for them when they’re toddlers, wait until they have a better grasp on the concept, and help them open an account and deposit money.
Use this as an opportunity to talk about spending and saving and your family’s typical mix (for example, spending 70%, saving 20% and giving 10%). Smart spending and living within your means is a life lesson that can be taught early.
Step 3: Pick an interest bearing savings account.
When the time is right to open an account with your child, don’t just head to the same bank you’ve always used—use a site like Bankrate to explore new options. Online banks and credit unions often offer better interest rates for savings account, even for minors.
Bottom line: There are great options out there, so do your research. Don’t make the mistake of sitting on $1,000 earning no interest in a savings account under your child’s name. Set an intent for the money and involve your children, or if they’re too young to be involved, you might consider closing those accounts and dumping the money in a 529 plan. You’re more likely to see it grow.