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Child Development Accounts

Posted Nov 09 2010 6:37am

Some policymakers have called for the creation of Child Development Account (CDAs).  CDAs are basically savings accounts to which parents and/or the government to contribute.  Children turning 18 can use the funds for various uses such as college tuition, purchasing a home, or starting a businesses. The SEED for Oklahoma Kids ( SEED OK ) project aims to create CDAs through 529 College Savings Plans.

Creating a pool of saving for a child’s future gives these children some liquidity to pursue their dreams.  The question is, why would the government need to set up a program like this?  Most parents will save money for their child’s future.  The CDA may be useful in the case where parents have hyperbolic preferences and under-save for their children’s future. If parents save optimally, however, CDAs may crowd out other forms of parental saving for their children and may decrease the parent’s financial flexibility.

Another motivation for CDAs is redistribution.  Some researchers believe that “ CDAs may effectively interrupt the cycle of transgenerational poverty .”  Poorer children may receive lump sum government contributions or higher match rates.  The government in essence believe that any redistribution to children should be directed towards improving their ability to attend college.  While this may be a good idea, redistributing funds to poor parents directly may allow them to send their child to better elementary, middle and high schools, to attend extra-curricular activities, or allow high-school children to forgo working during the school year.

Politically, redistributing more money to poor parents, however, may not may be politically feasible.  Poor parents are likely a less sympathetic recipient than poor children.  By targeting children, some policymaker’s goal of redistribution to the poor may be met though targeting this specific group.

It is possible, however, that CDAs will actually redistribute money towards the rich.  If CDAs are tax deductible, rich parents may receive more benefits in tax deductions than poor parents receive in subsidies.  This may be especially true if penalties for withdrawing funds from CDAs exist and thus poor families may incur penalties if their is an illness in the family or a parent loses their job.

The best option is to have the government deposit a lump sum into an account for each child born.  If birth rates begin to rise, however, this policy may become more expensive than anticipated.

The idea of CDA’s is full of good intentions, but instituting this policy decreases a parent’s control over their own income and could even undermine redistributionary goals.

Blog Post Appendix: CDAs in Other Nations

  • Canada provides all children with a tax-deferred savings vehicle to encourage savings for post-secondary education. The first C$2,000 deposited every year by parents or children is eligible for a 20 percent match, with an additional match for low-income families. A grant program supplements the savings of middle- and low-income households, providing an initial grant of C$500 and an additional C$100 annually, in addition to the match. The funds accumulated in the account must be used for post-secondary education or the government funds must be returned.
  • Singapore provides a CDA account to all children from birth to age 6. Savings accumulated by age 6 are matched at a 1:1 ratio up to a cap of S$6,000 to S$18,000, depending on the child’s birth order. (Because Singapore’s program is meant to promote population growth as well as child development, larger financial incentives are available to the third and fourth children of a household.) The savings in the CDA account can be used for child care, education-related expenses and medical expenses. Unused funds can be transferred to a college savings account when the child turns 7 years old.
  • The United Kingdom provides all children with a tax-advantaged Child Trust Fund at birth seeded with an initial deposit of £250 (or £500 for lower-income children). An additional deposit of £250 (or £500 for lower-income children) is provided at age 7. Unlike Canada’s and Singapore’s programs, the U.K.’s program does not provide a savings match. Another difference is that the funds in the U.K. may be used for any purpose after the child reaches 18 years of age.
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