The Under 40 Financial Planning Guide: Transfer Money to Your Kids

Although it may not seem to be a way to save money, giving money to your kids can actually reduce your tax bill.

The theory is that your kids are in a lower tax bracket and therefore will pay lower taxes on earnings than you would. For instance, assume that you were able to save $10,000 for your daughter's college education. If you give her that $10,000, and she earns $600 of interest, she will pay no taxes on that interest. If you keep the money for her, and you have a marginal tax rate of 33 percent, you will pay $200 in taxes for the same earnings.

Until your child turns 14, if she (or he) earns more than $1,300 of investment income, the IRS can tax the rest at your rate (under the so-called "Kiddie Tax"). While this is bad news for Macaulay Culkin's generally miserable family, it probably won't affect you until you have moved a large amount of money into your child's account. Even then, you still save taxes on that initial $1,300. Also, if you invest in longer-term investments, such as stocks, you can avoid recognizing income until your child is over 14, and the regular tax rates apply.

After age 14, the benefit of having earnings in your child's name can provide an even greater tax advantage, assuming that they will be making less money than you do.

This is best done through a custodial account at a brokerage firm or mutual fund that will allow you to control the money as your child grows. One last catch: When your child is old enough to control the account( 18 in most states), she could spend all the money you saved on a new Jet Ski rather than on the college education you had been planning.