5 Smart Ways to Save Money for Your Children

Whether you’re putting money away for college or a rainy day, here’s a guide to making sure it grows.

By + More

When Beth Moynihan, 28, and her husband, Sean, 29, found out they were expecting their first child in March, they quickly began wondering how, and if, they should start saving for future college costs. "Both of our parents were able to pay for our undergrad education, so we probably want to do a 529 plan," says Beth, adding that they also want to put money away for general expenses, such as future weddings and house downpayments.

[In pictures: 10 Ways to Improve Your Finances in 2011.]

Until recently, the couple, who lives outside of Baltimore, had saved for two purposes: retirement and a house downpayment. Beth, a nurse, and Sean, an engineer, put most of those savings into the stock market, where it's taken a beating. That leaves them wondering if they should put their child-related savings into safer spots, which might not pay much of a return. "I don't want to risk too much up and down," says Beth.

So what should new parents like Beth and Sean do with their savings? It turns out that there are some new strategies that work better than the traditional methods of saving.

The old methods include opening a Uniformed Gifts to Minors Act account, which automatically transfers into the child's name when he or she becomes an adult (18 or 21, depending on the state). The downside is that because the money automatically transfers, parents have no control over the funds after the child reaches that age, which means the child could spend it on anything. Similarly, buying a savings bond from the Treasury Department, which was once a favorite way of putting money aside for newborns, carries such a low interest rate today that there is little chance of keeping up with inflation, especially over the long-term. Certificates of deposit present the same problem.

Here are five new, smart ways to save instead:

1. A 529 college savings account: According to a recent survey by TD Ameritrade, 57 percent of adults have never heard of a 529 plan, even though financial advisors agree that it's the smartest way to save for college tuition. The accounts, which are sponsored by states, allow parents to invest after-tax money that then grows tax-free and remains tax-free if you use it to pay for tuition.

"Depending on the age [of your child], you will be more aggressive, and then become more conservative as your child gets older," says Jim Stoops, vice president and financial consultant at Charles Schwab. Many plan administrators offer funds that automatically make that shift for investors. Stoops adds that many employers let workers automatically funnel money from their paycheck into 529 accounts.

The accounts come with few limits on how much parents (or others) can contribute, regardless of income level. Parents have a lot of flexibility and can choose plans administered by any state, which means it pays to do some research comparing investment options and fees.

[In Pictures: 12 Money Mistakes Almost Everyone Makes]

Some companies, including Upromise and Fidelity, also offer shopping rebates that go directly into 529 accounts. "I also think parents should encourage relatives to write checks toward a college savings plan instead of spending wildly on toys and video games for birthday and holiday gifts. UGift is a wonderful way to do this. It's a savings platform that's linked to 529 accounts administered by UPromise," says Stacey Bradford, author of The Wall Street Journal's Financial Guidebook for New Parents.

2. Prepaid tuition: Many states offer prepaid tuition plans, which let parents buy tuition at today's rates, essentially locking in a lower price, regardless of how much tuition rises. What many parents don't realize is that states let you use that pre-paid tuition at any school, including private colleges, anywhere in the country. That loophole makes prepaid tuition plans one of the smartest options available. "You can start buying tuition at today's rates, and the money is guaranteed by the states," says Stoops.

3. Brokerage accounts: Investing after-tax income into a brokerage account dedicated to your child provides maximum flexibility and the potential for high returns over the long term. Parents can set up an account directly linked to their paycheck, so money is transferred into the account each pay period, just like with their 401(k). "I always advocate automatic, biweekly contributions," says Stuart Rubinstein, managing director of client engagement for TD Ameritrade.