Many parents are anxious about providing for their children into adulthood but they can start to share this duty by gradually incorporating their kids into money management decisions.
Not only is this a great way for kids to develop their financial education, but they will also understand the critical importance money plays throughout their life.
For parents who want to provide a wealthy financial future for their children, here’s how to get started:
— Address current financial needs.
— Invest in children’s future.
— Grow children’s earnings.
— Teach kids how to invest in themselves.
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Address Current Financial Needs
It’s never too early for parents to start including their children in money decisions. There are many investing tools to utilize to jump-start their investments.
If you’re opening a savings account for a child, you can establish a custodial account where the parent is the guardian or custodian of the account and the child is the beneficiary. The guardian controls the account until the beneficiary reaches age 18 or 21, depending on state laws.
A custodial account can be set up at a bank or an investment firm. In a custodial account, you and your child can decide to invest in individual stocks, mutual funds, exchange-traded funds and other investment securities. Although the adult opens the account on the child’s behalf, the legal holder of the assets is the child. Making investment decisions jointly is not only a valuable learning experience but can help the child take early ownership of their account.
The custodial account makeup is beneficial to parents since investment income from custodial accounts in the form of interest, earnings or dividends is taxed at a child’s tax rate, which is lower than that of the parents.
On the first $1,100, the tax rate may be as low as 0% and unearned income more than $2,200 may be subject tax using rates and brackets for estates and trusts.
Those looking to establish good money skills should start with the basics, recommends Howard Dvorkin, chairman at Debt.com, in Fort Lauderdale, Florida. Dvorkin recounts going to the bank as a young man with his parents and opening a savings account. He explains how he repeated this process with his own kids.
“At a very early age, I took my kids to open their savings accounts, where they physically deposited checks. When the account hit a certain balance, I was able to open money market accounts for them to earn more money,” Dvorkin says.
The biggest mistake people make in investing is they don’t have the right outlook in investing money, says Timothy McGrath, managing partner of Riverpoint Wealth Management in Chicago.
“The rule of thumb I use: If you need the money in five years or less it should be in a savings, CD (certificate of deposit) or money market account or someplace that it’s liquid. If you need the money in less time than that, there’s a possibility you could invest your money and not get back what you put in initially,” McGrath says.
If children receive monetary gifts from relatives throughout the year, parents may want to set this money aside for their children’s future.
If your child is at a young age and they won’t need this money until they’re 18, it doesn’t have to be in a liquid position.
“They can invest that money more aggressively to get better returns,” McGrath explains.
“However, if your child is 14 years old and you decided to save gifts from relatives now to use for college, this money shouldn’t be invested in stocks or bonds,” he says. “Rather, you want a more liquid position since there’s not enough time to weather a storm.”
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How Parents Can Invest for Their Children’s Future
For parents or guardians looking to fund their children’s education, a 529 tax-advantaged account is an optimal savings vehicle for K-12 tuition or college tuition.
A 529 plan, otherwise known as a qualified tuition plan, is a tax-advantaged savings account used for education expenses. Unlike other tax-advantaged savings accounts, a 529 has no income limits for plan contributions.
Anyone can contribute to a 529 plan, whether it be through monthly contributions or gifts from friends and family.
Withdrawals from a 529 account paid toward qualified education costs are not subject to federal income tax on capital gains from investments. However, 529 funds used for noneducational expenses are bound by federal state and income taxes along with a 10% federal tax penalty on earnings, and it may be subject to state income taxes.
A 529 is more flexible than a traditional savings account. For example, if the original beneficiary decides not to attend a trade or vocational school, college or other postsecondary educational program, the account can be transferred to another child or family member as the new beneficiary.
Earnings from 529 plans grow tax-free over time. The earlier an account is opened for the beneficiary, the more time the funds are invested, which translates into greater earnings.
When choosing a 529 plan, make sure it is affordable, says Ksenia Yudina, founder and CEO of UNest, an app that families can use to save and invest for college. in North Hollywood, California.
Depending on which state you live in, you may have an opportunity for tax breaks for opening and contributing to a 529, and minimum contribution requirements vary. This is beyond the reach of many families, Yudina explains.
“Look for a plan that’s easy to manage. Without a family-friendly interface or good online or app-based resources, it can be tough for families to review their progress or change their contributions,” she says.
Grow Children’s Earnings With a Roth Account
Parents saving for children’s future for noneducational purposes can consider a Roth IRA, which is an individual retirement account that provides tax advantages for retirement savings. Money in the account grows through contributions and earnings free from taxes. Funds can be withdrawn without tax penalties after age 59 1/2.
Experts recommend starting to establishing a Roth IRA for your dependents as early as you can. A Roth IRA can be comprised of any type of investment such as stocks, bonds or mutual funds.
“Clients are always asking me, ‘I want to help out my kids down the line, what should I do to help them out?’ To me one of the best things they can do is open them up a Roth IRA” McGrath says.
The minor qualifies for a Roth IRA once she has a job and earns annual income.
“A Roth IRA can show them the true value of compounding. Assume your teen earns $4,000 this year. Have her put $2,000 of those earnings in a Roth IRA,” says Philip Weiss, principal at Apprise Wealth Management in Baltimore.
If she has 50 years until retirement and earns an average return of 5% a year, it will be worth nearly $23,000 when she retires, Weiss details.
This account is a great learning tool for children that helps build the “saving for growth” mentality.
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Teach Kids How to Invest in Themselves
Starting at a young age, children must be taught to save money and that people cannot become wealthy by living beyond their means, regardless of their income bracket.
“I ask my clients: ‘What are you doing to raise financially responsible children?’ If you want to teach your children anything, you should teach them how to budget and save,” McGrath says.
If you aren’t sure about finances, start by doing research and steadily become well-versed about personal money management in the near and long term.
“It’s important to instill the value of savings in our youth, as they are our future,” Dvorkin says.
“As consumers, we are constantly hit with advertising and promotions. This is subjecting our children to the concept of spending on material items rather than saving.”
Factoring in some of these financial tools along with your children’s participation is an invaluable learning development for financial literacy and will help them understand that budgeting and saving are what will create a path for a financially successful future.