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!
Photo Credit #1: Flickr Creative Commons
Photo Credit #2: Flickr Creative Commons
Editor’s note: A huge thanks to Matt for the awesome support, advice, and of course great content. 🙂
49 responses to “What Should You Do with Your Kids’ Gift Money?”
All of my kids gift money goes into the 529 accounts. They are only 2 and 4 and have thousands of dollars saved already!
Yep, we do the same thing. It’s pretty awesome!
My opinion….let the 2 year old have a little of the gift money so he can get a small toy. By letting him choose a toy within whatever $ amount you choose, he already begins to learn how to make a wise choice and that things cost cash money. The rest can go into college fund, savings etc.
We’ll definitely do that with our kids when they get a little older. I’m not sure he’s old enough to really get that kind of decision-making yet, but maybe we should try it out a little bit. I do like the idea of splitting the gift money 50-50 though. Let’s you have the best of both worlds.
This is what we do. When ze has the gimmes, we can suggest ze buy it hirself.
I really like the idea of a 529 in the child’s name.
And to me, the fact that it can only be used for education is a good thing. It NEEDS to be for school expenses so you’re not tempted to spend it. And it needs to be for school expenses so the two-year-old won’t be tempted to spend it on frivolous things at 18.
In the future, you can even tell potential gift-givers to contribute straight into the account 🙂
I can see both sides of it. I agree with you to some extent, and really decisions like that are a part of what parenting is all about. But another part of that is helping your kids learn how to make their own independent decisions and giving them access to money is a part of that. So I think that in the end a balance is probably best.
When I was little (between 6-8 years old), a couple of my friends would get lots of money from grandparents for every Christmas and birthday. I think it just went into a regular savings account for them. Their parents let them know how much was in their account, and they could choose to use their money however they wanted– they were cautioned, however, that it was up to them to pay for half of their summer camps and other “for-fun” activities (like summer enrichment classes, etc.). But if they wanted to use it to buy toys, they could. They just had to be aware of their finances and how much things cost. Made them (and their friends) very aware of the value of money. They all grew up very fiscally responsible.
Also, when I was little, starting at about 5 years old, I would get a weekly allowance (about 5 dollars, but now with inflation maybe 10 would be more reasonable). I could use that allowance money for anything– movies, toys, anything. I quickly learned the value of my allowance, and though blowing it all on a gum drop machine or an arcade seemed tempting at first, I soon learned how to save up for things that I really wanted.
I think those are both great approaches. Thanks for sharing! We plan on doing something similar when our kids get a little bit older, particularly with allowance. I really like the idea of giving them money that’s 100% theirs to do with as the please so they can learn from their own decisions.
We have a registered education savings acct for kiddo (RESP in Canada) which all ‘gift” money goes into. We also made a very clear point that we would much rather get $20 here and there then a bunch of silly stuffed animals for gifts until she’s old enough to know any better. I figure we have another 2 or so years before she really catches on 🙂 When she gets older and receives monetary gifts she will have a regular bank account as well as a savings acct where she will learn the importance of balance. Save a little (either short of long term) as well enjoy a little money. I certainly can’t expect at 16 year old to save 100% of gifted money but she can understand the importance of balancing wants and needs (post secondary savings)
Your approach sounds almost exactly the same as ours. I like it!
Until three years ago when my son turned 5, we took all gift money and put it in my son’s 529 account. For the last three years, we have been doing a combination, where the larger gifts (i.e. greater than $200) go to his college account and the rest goes to him to manage. We use this money to help him learn how to manage his money and teach him lots of lessons along the way. After some initial mishaps, he has over $600 “saved” and we plan to open a UGMA account for him next year where he will be part of the investing process of his own money.
I like that compromise. I’ll be interested to hear how the investing experiment goes too. I have ideas in my head for how to handle it but it would be good to hear about some real world experience.
As someone who doesn’t have kids but does have nieces and nephews, so I’m doing the gifting instead of receiving, I would just ask what the giver intended. While the kids are little, and are as happy with a cardboard box as they would be with an expensive gift, I’ve considered just tucking the money away until they’re teenagers or in college and could really use an infusion of ‘fun money’. Or save it away so that when they have an opportunity to go on a big trip in high school (Spanish club took a trip every year and the German club went to Germany) they have the money already set aside.
Of course I don’t know what kind of money you’re talking so I could be way off but I’d generally save it for college or use it for experiences that the kids would dig but I might not spring for otherwise like a children’s museum membership or tickets to the Wiggles live or Disney on Ice or if the grandparents live far away, a trip to go see them.
I think you’re right that it’s often good to ask the giver what the intended. My experience with my own family is that they’re excited when we put it away for college, but everyone is different. I also like your emphasis on experiences instead of things. I like it as a general principle, but I can speak from experience that no, we don’t need any more toys! Those things take up a lot of space!
I had to laugh – you wrote that your boys were so old and I thought they are so young! LOL! We have a 529 plan for the girls, which we contribute to. When they were really young, we put money they received in their savings account. Now any money they receive they allocate towards their save, spend and share goals. I actually opened a custodial account for my nephew a few years ago when he asked me to stop giving him presents and to instead invest the money for him. Smart kid. 🙂
Haha, yeah objectively I know they’re still young, but I mean really? 2 years? He’s talking in full sentences now and singing his ABCs! I mean, when the hell did that happen???!!!
Love reading about this as the husband and I are contemplating having a little one of our own 🙂
As we’ve looked into the 529’s and other educational savings plans, I think we’re leaning more towards investing the money on a fund that’s easily accessible and wouldn’t incur charges if its withdrawn for any purpose outside of funding education costs. While we would LOVE for our children to choose the college route (which we both did) I wouldn’t necessarily be heart-broken if they decided to pursue music or art or start a business of their own. It’s all about setting them up to succeed in a field they’re passionate in. If it’s the education route, awesome – if it’s being the best organic farmer, for example – that’s OK too.
Thanks for the post!
I think that’s a really great line of thinking. Of course, it doesn’t have to be 100% either way. You could always put a little away for school and a little away for whatever. 529 money doesn’t just have to be for college either. It’s any post-secondary education. I used it for my CFP courses that were run through a University but was an online self-study program. So it can sometimes be a little more flexible than people might think.
That’s great info, Matt!
That definitely helps with flexibility – we might just have to do both 🙂
Hi Matt, love your piece! I don’t have kids yet, but I’m still weighing my options in preparation. I’m leaning more towards a saving or investment account since the education funds have more restrictions (it’s great to hear that you were able to use it on your CFP, congrats!). Although I value my college degree I recognize it’s not for everyone. I hope to build a stipend fund for each child to use towards their own passion when they come of age. How I build that is still up in the air.
Thanks Taylor! I really like your mindset of allowing your children to use the money to chase whatever dream they have. You hear from so many people whose parents pushed them in one direction or another, so it’s great when someone recognizes the value in letting their children choose for themselves. I’m sure you’ll figure out a way to do it that works for you.
Great post, Matt! When our kids were younger, we put all of their cash away too, but now that they’re older, we let them spend it as they choose. Earned income for them must be split up: 10% into a savings account, 10% into a giving account, and the other 80% to do as they please, but all gift money is left to their choice since we’ve taught them well about the power of saving and investing. 🙂
Nice system. Thanks for sharing!
I love the idea of investing it. I have jumped on the Betterment bandwagon and love it, but do you know if they offer custodial accounts? I think the Betterment simplicity would be good for starting to teach a child about investing. Definitely going to look into this, because as crazy as it seems, my 6 month old already gets gift money……crazy!
I don’t use Betterment (I prefer investing directly with Vanguard) so I don’t have a definitive answer to your question. A quick search of their site though turns up 0 results for the terms “custodial”, “ugma” and “utma”, so my guess is they aren’t offering it yet.
When our kids were very young, it just went into a savings account – but now that they’re older we usually let them keep some of it to buy something they want, and put some of it into their savings.
Sounds like a good balance.
Tough question to answer, since there’s some upside with each option. I’d lean towards the 529 and, should your child decide not to go to college, you could simply say the taxes and 10% penalty are their punishment for turning down such a great opportunity. That’ll teach ’em.
Haha, yeah! You get em!
Interesting, it sounds like the laws in the US are rather different than they are in Canada. I think I would be tempted to tell the kids they have to save some portion of their funds, but let them direct most of their money themselves. When they are super-young, I would probably tell relatives/grandparents that monetary gifts specifically for education would be the most welcome gift.
I go back and forth with whether I want to force them to save money (once we give them that kind of decision-making ability). Right now I’m honestly leaning towards no, but obviously there are benefits to doing so and we may end up going that way. I just like the idea of 100% letting them learn from their own decisions.
I’m putting the gift money in a 529 plan, but when in the future when the child is older I might put a little in a savings account and investment account. One of the ways I learned about compound interest and investing was when my parents showed me “my” account and I was excited to save because my money was earning more money.
That’s cool that your parents did that. I definitely want to teach my kids the basics of saving and investing from an early age, with the hope that it all feels pretty comfortable and normal to them when they’re old enough to do it for real. I think that early exposure is really key.
I do a bit of both: I put half into a college fund and the other half into a savings account for them.
My kids are young (four and one) so they haven’t exactly been clamoring for high-end items that I’m not willing to buy. But should the day come when they want to purchase something I’m not willing to, then I’ll have them use their savings account.
I plan to do this half-and-half business for all their childhood lives. Anytime they earn any type of money, whether gift or even a job they have, I would have them put half (or at least a huge amount) into the college fund. That way, they get used to the idea of setting aside a big chunk of money into something long-term (eventually something like an IRA or 401(k)) and not feel like such a shock.
Letting my kids use their own money to pay for things that we wouldn’t otherwise buy them is definitely a part of our plans as well. I think that’s a great way to give them independence and let them learn the consequences for themselves.
My mom used to put all gift money and money I won from talent shows and competitions in a bank account which she gave me the info to after I graduated college. She also handed me a bunch of savings bonds people gifted me as a baby. They will mature in the next few years, and are actually worth quite a bit. I wonder if people still gift them.
That’s a really cool idea! My grandparents gave me savings bonds but I think I cashed them in too early. Nice work being smart enough to hang onto them.
I don’t have kids yet… but I would let them use a small portion of the money to treat themselves. I would probably invest/save the rest of the money to give to them on there 18th birthday.
Once ours are a little older, some if not all of their gift money will be theirs to do whatever they want with. Do you think you would let your kids have a say in how the other money was being saved/invested?
Right now we have all of it a standard savings account. Soon it will be moved to a low cost index fund through Vanguard.
I love me some Vanguard!
I came here for ideas on what to do with the ~ $20 my kids (1 and 3 years old) get for Christmas and birthdays each year. College savings? 529 account? Until my kids get hundreds of dollars from their relatives each year (ha) I think we’ll be sticking with the piggy bank approach.
My ex husband was put in charge of my children’s UTMA accounts in the event of our divorce by the judge. I thought he was adding money to these accounts, and that my payments to these accounts as he told me he was. My daughter is 18 and in her first year of college. She asked her dad for the money but he told her there wasn’t any money left. He told her that his business was doing poorly and he needed to spend the money on that. He also “gifts” both of my children money for income tax purposes. This money was also not given to her when she turned 18 last February. Can this be legally done?
Hey Sarah – I’m sorry to hear you’re going through this. This is a question you need to ask an attorney or an accountant. I wish you the best of luck!