March 24, 2014

Judith Ward Judith Ward, CFP®, is a senior financial planner and vice president of T. Rowe Price Investment Services.

Opening a 529 college savings plan and contributing to it regularly can make a big difference in your children's lives—and so can setting up their own Roth IRA, which will help give them a jump-start in life.

As a parent, you want your children to realize their full potential with rewarding careers and financially stable lives. The path to opportunities before them often begins with a college education—a financial goal you and your children can reach with some forethought and a regular savings plan. Helping to pay for the costs can give them a significant advantage. The majority of student aid comes in the form of loans that will have to be paid back, meaning you or your children would have to handle debt in the future to finance that important gateway to success.

It's never too early for parents to start saving for their children's higher education. A 529 plan can be opened as soon as they're born or even before they're born. Parents with older children also have a valuable tool available to help their children get a jump on their retirement savings—a Roth IRA that can potentially grow to hundreds of thousands of dollars or more over the course of their lives.

On the Road to College

A 529 college savings plan is one of the first things, financially, that you can do as a new parent to help your child. Any growth is tax-deferred, and any earnings are free from federal tax and, in most cases, state tax—provided you use the money for qualified higher education expenses. You can start a plan regardless of income level, and anyone—including relatives and friends—may contribute to it, up to a limit established by each plan (generally ranging from $235,000 to $450,000). Any unused money in one child's account can be used to benefit another member of the beneficiary's family. If you distribute the money for anything other than qualified educational expenses, you'll have to pay taxes and a 10% penalty on any earnings.* A 529 savings account is a great vehicle to prepare for the rising costs of college and reduces your need to borrow money when your kids head off to school.

Giving the Gift of Education

Grandparents or anyone else who wants to contribute to your children's futures can make cash gifts to a 529 plan. You can give up to $14,000 to each of any number of people in tax year 2014, without facing gift tax consequences.

Rules for Roth IRAs

One of the best ways to inspire your children to save and think about their futures is to help them set up a Roth IRA. With some earned income from jobs, such as mowing lawns or babysitting, your children can have a retirement account opened for them. Contributions are made with after-tax money, and any earnings are free from taxes for withdrawals made after age 59½.**

And you can make contributions on their behalf—for example, you may choose to contribute a certain amount to their accounts each year based on their wages, up to a maximum of the amount of the child's earned income or $5,500 (whichever is less). The Roth IRA is a great account because of the flexibility it provides. Saving for retirement might seem foreign to young people—and they're probably not even thinking about what kind of account they should have. But once they understand how much their money can grow, saving can be very exciting to them.

Raising Money-Smart Kids

Simple ways to teach your children valuable lessons about money:

Show them account statements. Teens can see their own money begin to grow and grasp the concept of compounding by being actively engaged with their accounts. Just as important, they'll adjust to the possibility of losing money on an investment. Teens who start investing $2,000 a year in a Roth IRA at age 15, for example, would amass about $200,000 by age 45 and $870,000 by age 65, assuming an average annual return of 7%. But if they wait 10 years—until after college—your children would have "just" $88,000 by the time they're 45 and $427,000 by age 65.

Giving Children a Head Start

Talk to them about money. Opening a Roth IRA for your child provides more than tax and financial advantages—it is an opportunity to teach investment lessons. You want to involve them in some of the decisions about what to invest in. Have them help with the investment selections and encourage them to look at the financial statements—it's a great way for them to begin their financial education.

Create an incentive program. Teenage children might not be enthusiastic about putting their wages from work into a Roth IRA that they probably won't touch for half a century or more. One suggestion is that parents set up an incentive program, whether that means matching 50 cents or $5 for each dollar children contribute or just matching what they earn. A matching system can help them to understand the value of saving for a financial goal without having them contribute a large portion of what they earn to the account.

Teach Your Children Well

Planning for the cost of college is a great opportunity to talk to your children about investing and financial goal-setting. They'll see firsthand how important it is to prepare for a major expense. And opening and contributing to a Roth IRA is a practical way to get your children thinking about their futures beyond college, while witnessing the powerful benefits of saving. Actively engaging with and involving your children in appropriate and relevant financial matters can be the most effective way to help them to become invested in their future.

Please note: A 529 plan's disclosure document includes investment objectives, risks, fees, expenses, and other information you should read and consider carefully before investing.

* You may also need to recapture any state income tax deduction that was taken on your contributions.
** Withdrawals of principal are always income tax- and penalty-free, and withdrawals of earnings from Roth IRAs can be made income tax- and penalty-free, provided the account was opened at least 5 years earlier and the individual is age 59½ or older, disabled, or certain other exceptions apply.