The unequal distribution of wealth in the United States often results in some children starting life at a disadvantage. Lawmakers are now considering whether federal children’s savings accounts could help bridge this gap.

One proposal, known as the 401Kids Savings Act, aims to create savings accounts for all newborns. Low- and moderate-income families would receive federal contributions if their modified adjusted gross incomes fall below certain thresholds. Additionally, children in households that qualify for the earned income tax credit would receive extra aid. All families would be eligible to contribute up to $2,500 per year into these accounts.

According to the proposal, a qualifying low-income newborn born to a single parent could accumulate up to $53,000 by the time they turn 18. This significant sum could be used to support their education, training, home purchase, or even start a business.

Currently, children’s savings accounts are available statewide in seven states: California, Illinois, Maine, Nebraska, Nevada, Pennsylvania, and Rhode Island. As of the end of last year, there were 121 children’s savings account programs across 39 states, serving 5.8 million children. These programs aim to mitigate the effects of unequal wealth distribution, particularly among Black and Hispanic households compared to white households.

“All the evidence from existing programs shows that money not only unlocks opportunities for kids, but it’s also a smart investment that goes right back into the economy down the road,” said Sen. Ron Wyden, D-Oregon, chairman of the Senate Finance Committee, during a Tuesday hearing.

However, implementing a federal program may come with significant costs to taxpayers, noted Sen. Mike Crapo, R-Idaho, the ranking member of the committee. “Expanding options to save is a worthy goal, but we must do so in a way that does not exacerbate already out-of-control government spending or create another unsustainable government program,” Crapo said.

State Child Savings Accounts Show Promise

Even without federal funding, children’s savings accounts have demonstrated the ability to help families build wealth. William Elliott, a professor of social work at the University of Michigan, testified that existing programs provide small initial deposits ranging from $5 to $1,000.

In the SEED for Oklahoma Kids experiment, which deposited $1,000 on behalf of randomly selected newborn participants, including low-income and Black families, the average child now has about $4,373 in their account at age 14. “Even when family savings are minimal, significant assets accumulate in these types of accounts,” Elliott said.

The benefits of these accounts extend beyond financial preparedness for college. They have also been shown to enhance children’s early social-emotional development, math and reading scores, and increase the likelihood of college enrollment.

For example, the Alfond Scholarship Foundation in Maine provides all babies born in the state with a $500 grant towards either college or future training. To date, the foundation has invested about $78 million on behalf of 156,000 children. Families have contributed approximately $236 million, and they have received about $29 million in matching grants from the state. The total invested grew to $477 million in the market as of the end of April.

Early data shows that the $500 investment families receive has a significant impact on their aspirations, savings behaviors, and engagement with education. “We don’t have to imagine what a national platform would look like,” said Colleen Quint, president and CEO of the Alfond Scholarship Foundation. “We can see it happening now.”

Concerns About Inflation and Tax Implications

Critics of the children’s savings plans point out that the government already deployed massive amounts of stimulus money during the pandemic, which hasn’t meaningfully boosted long-term savings. “Savings rates are again near historic lows,” said Adam Michel, director of tax policy studies at the Cato Institute. “In this case, checks from the government fueled more inflation than they did wealth building.”

Reforming the tax code can help address wealth inequities for young children. This could involve preventing double taxation on wages when they are earned, as well as on interest that accumulates on savings. While such disincentives have been reduced for 401(k)s and 529 plans, these accounts still come with restrictions on how the money may be used, which might discourage low- and middle-income individuals from utilizing them.

The 401Kids proposal stipulates that children can only access the funds once they turn 18. The money would have to be used for education, training, a home purchase, or to start a business. The funds could also be rolled over to a Roth individual retirement account or an ABLE account for children with disabilities.

Some experts suggest that Universal Savings Accounts, which offer more flexibility in how the money can be used, might be a better solution. “Universal Savings Accounts have the benefit that they do not discourage savings for those who are concerned that the conditions for withdrawal would stop them from addressing an emergency in their family,” said Veronique de Rugy, senior research fellow at The Mercatus Center.

The debate continues as lawmakers weigh the benefits and costs of implementing federal children’s savings accounts to address wealth inequality and provide a more equitable start for all children in the U.S.