Best way to house $$ saved for kids

[annamal instinct]

I'm thinking of how best to save money for my kids. They'll get gifts of money over the years, and I'll give them a MMM-style allowance ($ for miles biked/walked). I'm thinking of an IRA. I want to minimize tax penalties and put it in something more interesting than a savings account. The oldest is 3.5 years old. What would you do?

[TVRodriguez]

For a regular or Roth IRA, the kid has to have earned income reported to the IRS (i.e., not your mileage allowance).  Most 3 year olds don't have this.

You could do a 529 account or a Coverdell education IRA.  Growth is not taxed if it's held and used for educational expenses, generally speaking.  Some places have prepaid 529 plans where you pay now for in-state tuition and kid later goes without paying then-current rates.

[lifeanon269]

What's the purpose of this money? Is this money for them to spend eventually once they start to get older or is this strictly for long term savings of some kind?

I know it isn't everyone's cup of tea, but I'd give them a bitcoin wallet and store some money in it for them. In my opinion Bitcoin is an excellent store of value long term and it doesn't require a 3 year old to actually hold an account with any institution.

If they ever have a need to spend it, you could convert it back to dollars for them through an exchange, otherwise it could just sit in their wallet. Once they get older and start to learn computers, you could allow them to have access to their wallet so they could see their savings amount over time.

[AZDude]

Open a custodial account for your child and invest the money.

[TVRodriguez]

Thoughts on the tax savings of a 529 vs. the flexibility of a custodial account?

This is off the top of my head, so do your own research to confirm. 

In the US, UTMA accounts are uniform transfer to minors act accounts, sometimes called custodial accounts.  Most states allow you to set one up with you as the person in charge and the child as the beneficiary.  You get to direct investment of the money and can set up a bank or brokerage account under UTMA.  You can use the money for the benefit of the child, kind of flexibly defined.  Once the minor turns 21, though, it belongs to him.  He can use it for whatever he wants, including cocaine and art school (that's a joke--make it meth and law school to be more current).  (UGMA accounts were the same but the age of majority was 18.  I think most states have UTMAs now but don't quote me on that--check your state laws.)  You must designate the beneficiary when setting up the account (no holding for "future children").  There is no income tax deduction for contributions.  In some states, if beneficiary gets notice of account at 21 and does not move to take it over, the account can be put back in the donor's control until age 25.

529 accounts can only be used for educational expenses.  Educational expenses are generally broadly defined, but they must be educational, not for things like health insurance.  You must designate a beneficiary by social security number, but you can change the beneficiary once every 12 months.  So if you don't like how one kid is turning out you can use the cash for the golden child instead.  The money stays in your control and can be a bank or brokerage account.  Some states allow you to take a deduction on your state income tax return for contributions to a 529 account.  There is no federal income tax deduction for contributions.  Growth is not taxable if funds are used for educational purposes of beneficiary.  Kid never gets control of funds in account.

Coverdell IRA is kind of a mix, but I know less about them than I do about the others.  I believe the kid gets control at 18, there is some possible deduction, there is a limit of annual contributions ($2000?), and it's supposed to be used for education?  I obviously was less interested in this.  I don't want my 18/21 year old getting control of money that I'm setting aside for college.  That's where my personal stance is.  Yours may differ.