Savings Accounts for Kids

The benefits of compound interest

If your child is under the age of 18, he may not be able to open a savings account without your help. Even if your child earned the money himself, the bank may insist that the account be opened as a custodial account under the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA). The type of custodial account depends on which act has been adopted in your state; most now use UTMA.

You'll have to sign as custodian to open the account, the title of which will read: Account of [YOUR NAME], as custodian for [YOUR CHILD'S NAME]. The account will be listed under your child's Social Security number, and all interest belongs to and is taxed to him.

When your child reaches 18 (or 21, if state law imposes that age requirement), the title of the account can be changed to eliminate the custodianship.

Having a custodial account is a great way for a child under age 18 to save money. She can look at her monthly statement or passbook to see how her money is growing. But the problem with a custodial account is that you, not she, have the power of the pen over the account. She must wait for you to put the money in or take the money out.

Some banks don't enforce the formality of a custodial account. They'll allow your child to open her own account as long as she can sign (not just print) her name. In this way, she can physically make her own deposits and withdrawals.

Some banks even go out of their way to attract kids as customers. For example, one bank in California offers a Looney Tunes Savings Club that features Looney Tunes characters on deposit and withdrawal slips. There's also the State Street Bank Kids' Club that gives stickers with each $5 deposit. The Washington School Employees Credit Union offers several Youth Clubs for savers of any age. For example, those 12 and younger can join Savvy Savers to set up a savings account. This entitles a child to a birthday card and semiannual newsletter.

Your local bank isn't the only place for a savings account. Credit unions may also offer savings accounts to the children of credit union members. Some offer special accounts just for kids.

Some savings banks even let your children mail in deposits. For example, Young Americans Bank in Denver boasts savers from every state and has no minimum deposit requirements.

Deposits in savings banks can be made whenever your child has the money to do so; there's no restriction on how often he can put money into the account. You'll want to encourage regular deposits, but your child can make them more or less frequently. There may be some restrictions on how often withdrawals can be made, however, and if deposits are made by check (for example, a gift your child received from his aunt across the country), he'll have to wait several days for the check to clear before withdrawing those funds.

Getting Interest

There's something very interesting about interest: It's a way to make money on money. Once your child gets the ball rolling by putting money into an interest-bearing account, it takes on a life of its own. This is because most types of savings accounts pay compound interest.

You may recall the old riddle you faced in elementary school. Would you rather receive $100 a day each day for a month, or start with a penny on day one and receive double the amount each day? The first alternative is tempting, and after a month you'd have more than $3,000. But with the second alternative, you'd be a millionaire in just a month even though you started with a penny. This is because of what's often referred to as the magic of compounding. In this example, we're talking about 100 percent interest each day, but most savings accounts today pay less than 3 percent annually (not 100 percent each day). The principal is the same, though. Here's an example to explain how compound interest works.

Say your child saves $100 at 5 percent interest. At the end of the first year, she'd have $105 ($100 investment plus 5 percent interest). At the end of year two, she'd have $110.25 ($105, plus 5 percent interest). At the end of the third year, she'd have $115.76 ($110.25, plus 5 percent interest). As you can see, as the size of the account grows, the amount of interest earned each year also increases because the interest rate is being applied to an ever-increasing pot.

The following chart shows how every dollar your child invests will grow over the years, depending on the rate of interest received (assuming annual compounding). As you both can see, if she saves $50 at 7.5 percent interest, she'll have $72 after five years ($50 — $1.44 shown in the chart).

To see how much your child must invest on a regular basis to reach a savings goal, or how much she'll have at the end of a set time if she has a particular amount to invest regularly, use a savings calculator that can be found at www.aba.com/aba/ConsumerConnection/persfin.asp or www.national-city.com/natcity/personal/savings/savcal. You just enter the requested information, and the computer will do the rest. You can, of course, vary the information (for example, change your child's savings goal) and recalculate the results.

Source: CCH Financial and Estate Planning Guide