6 Tax-Efficient Ways to Save for Your Child’s Future

As a new parent to my son, Archer, I’ve found myself exploring the most effective ways to secure his future financially. My wife and I, like many parents, want to ensure we’re providing for our child in the best way possible. Being a tax attorney and CPA, I’m keenly aware of the powerful tax-saving opportunities that can make a significant difference over the years. With careful planning, there are numerous strategies to save for a child’s future while reducing your taxable income.

Here’s a breakdown of some of the most effective, tax-advantaged ways to build wealth for your child.

1. Leverage 529 Plans for Education Savings

The annual gift tax exclusion can be maximized through 529 contributions. For 2024, the exclusion is $18,000 per beneficiary, per contributor (or $36,000 for married couples), meaning you can contribute significant amounts each year without triggering gift taxes. Additionally, there’s a unique option for “superfunding,” where you can front-load up to five years of contributions at once. This allows for a one-time contribution of up to $90,000 (or $180,000 for married couples), giving high-net-worth families a powerful way to jumpstart their savings and maximize tax-free growth early on.

As for how the funds can be used, 529 plans have evolved to cover a wide range of educational costs. Traditionally, they could only be used for higher education, such as tuition, fees, room, and board at colleges and universities. However, recent changes allow for qualified withdrawals to cover K-12 tuition expenses (up to $10,000 annually) and, in some cases, student loan repayments and certain apprenticeship programs. This flexibility makes 529 plans appealing for families who want to keep education savings options open.

2. Hiring Your Children in Your Family Business

If you own a family business, hiring your child can be a smart tax-saving move. By paying them a reasonable wage for legitimate work, you can shift a portion of your income into a lower tax bracket, potentially saving on overall family taxes. Not only is this strategy tax-efficient, but it can also provide your child with valuable work experience. Children under 18 working in a parent-owned business are exempt from Social Security and Medicare taxes, which can maximize tax savings further.

Once your child earns income, you can help them start a Roth IRA, using their earnings to make contributions. Roth IRAs grow tax-free, and your child can withdraw funds tax-free for qualifying expenses later, such as a first home or even retirement. This kind of setup builds wealth early and introduces them to the importance of tax-efficient saving.

The IRS requires that your child’s work must be age-appropriate and genuinely contribute to the business. For high-net-worth families, common roles could include basic administrative tasks or light office help. Ensuring the compensation is comparable to what would be paid to any employee doing similar work is essential to pass IRS scrutiny, making this a useful yet compliant strategy for reducing taxable income.

3. Strategic Wealth Transfer: Gift Tax Exclusions and Trusts

By pairing trusts with annual gifts, families can ensure wealth is protected and passed down in a tax-efficient manner.

4. Creating Investment Income for Your Children

Introducing your children to investing is a great way to build their financial foundation early and help them understand wealth management. By setting up custodial accounts, such as Uniform Transfers to Minors Act (UTMA) accounts, parents can invest on behalf of their children in assets like stocks, bonds, or mutual funds. The growth of these investments over time can help build a significant nest egg for their future needs, such as college expenses or a first home purchase.

However, one critical consideration is the Kiddie Tax. This tax rule applies to unearned income for children under 18 (or under 24 if they are full-time students), above a certain threshold—currently $2,500 for 2024. Under the Kiddie Tax, the first $2,500 of unearned income is taxed at the child’s lower tax rate, but any amount above this is taxed at the parent’s tax rate, limiting the tax benefit of shifting large amounts of investment income to children.

To maximize the benefits, consider focusing on investment types with low or tax-free income, such as growth stocks that don’t generate regular dividends or tax-free municipal bonds. Additionally, keeping income within the Kiddie Tax threshold can avoid triggering higher tax rates. Used thoughtfully, creating investment income for children is a powerful wealth-building strategy that—when managed with the Kiddie Tax in mind—can help your family build tax-efficient savings for the future.

5. Child and Dependent Care Tax Credit

The Child and Dependent Care Tax Credit is a valuable benefit for families incurring expenses to care for children under 13 or other dependents, enabling parents to work or seek employment. For the 2024 tax year, the credit allows you to claim 20% to 35% of up to $3,000 in care expenses for one qualifying individual, or up to $6,000 for two or more. This translates to a maximum credit of $1,050 for one dependent or $2,100 for multiple dependents.

With Donald Trump’s recent election victory, potential changes to tax policies may impact this credit. While specific plans regarding the Child and Dependent Care Tax Credit have not been detailed, Trump’s broader tax proposals include extending the 2017 Tax Cuts and Jobs Act provisions and introducing additional tax cuts. These changes could affect various tax credits and deductions, including those related to dependent care.

It’s essential to stay informed about forthcoming tax legislation to understand how it may influence your eligibility for and the value of the Child and Dependent Care Tax Credit. Consulting with tax professionals at Evolution Tax & Legal can provide personalized guidance tailored to your family’s situation.

6. ABLE Accounts for Special Needs Planning

For families with children who have disabilities, an ABLE (Achieving a Better Life Experience) account is a powerful, tax-advantaged way to save for future expenses without affecting eligibility for government benefits. Similar to a 529 plan, ABLE accounts allow contributions to grow tax-free as long as withdrawals are used for qualifying disability-related expenses, including education, housing, healthcare, and transportation.

For 2024, the annual contribution limit for an ABLE account is $18,000, aligning with the annual gift tax exclusion. Contributions can come from family members, friends, or even the beneficiary themselves, making it possible to crowdsource savings for a child’s future needs. If the beneficiary is employed, they may also contribute a portion of their income, up to the federal poverty level ($14,580 in 2024 for most states), allowing for even greater annual contributions without affecting their Supplemental Security Income (SSI) benefits, as long as the account balance stays below $100,000.

These accounts can provide significant peace of mind for families by ensuring there is a designated, tax-efficient fund to cover essential expenses. Given the complexity and potential limitations of ABLE accounts, it’s wise for high-net-worth families to consider using an ABLE account in conjunction with a Special Needs Trust to optimize flexibility and tax efficiency for their child’s future.

Putting It All Together: Building a Tax-Savvy Future