“Think of the Children!” – I’m sure you’ve heard this phrase before and today, well, we’re going to be thinking about the children. Your own children. And how we can financially help our kids in life. There are many different ways you can financially assist your kids. The strategies you implement will have to do with YOUR current AND future financial situation as well as your children’s current AND future financial situation. Proactive planning will do wonders for you and your children and the best time to make a plan is yesterday. Enjoy these financial strategies!
529 College Savings Account
Most people know that college is expensive. The 529 provides some relief. Your money goes into the 529 after tax (some states offer a deduction, but nothing for a federal deduction) and all the earnings grow tax free if used for qualified higher education expenses. The big advantage is the tax free growth. The only way you’ll get more tax free growth is by saving early and often in your child’s early years.
Pros: Tax free growth, dedicated college account, easy account administration, low effect on college aid.
Cons: used strictly for higher education (tax penalty applies on the growth if not used for qualified education expenses), gift tax limitations.
UGMA / UTMA
The Uniform Gift to Minors Act (UGMA) and the Uniform Transfer to Minors Act (UTMA) accounts are custodial accounts for kids. Your kids are the beneficiaries of the accounts, but you, as the parent / guardian, are the account owner. The parent saves and invests the money for the child until the child reaches age of majority, as defined by each state. At age of majority, the account is transferred over to your kids for their full control. This is a great way to give your children assets without any strings attached as the funds in the account can be used for anything.
Pros: Easy passing of assets without needing a trust.
Cons: No tax benefits, gift tax limitations, negative effects on college aid eligibility as compared to a 529.
Custodial Roth IRA
I’m a HUGE proponent of the Roth IRA. The tax-free benefits compounded over the years can be magical come retirement time! Why not open your child a Roth IRA at a young age? Children under 18 can’t own retirement assets, but you can open one for them. You act as the custodian on the account (you control asset direction) and your child is the beneficial account owner. At age 18 (age 21 in some states), your child can request to transfer the account in their own name. A small amount today can be a huge difference at retirement time for your kids.
Pros: Tax free growth, retirement accounts for your kids at any early age, no effect on college aid.
Cons: Kids need income to make the contributions to their accounts.
If you’ve heard me in the past, you know I’m not the biggest permanent life insurance person (putting it lightly). There are certain areas where permanent life insurance makes sense and this MIGHT be one of them. The idea is to get a permanent insurance policy on your own child’s life. You would own the policy until your child is of adult age (each state defines that differently). Why do this? Well, it’s that much less insurance your child has to purchase in the future. Plus, the cash value in these policies does provide some additional benefit.
Pros: less life insurance your future child will need in their earning years, cash value of policy.
Cons: Potentially expensive, a much more conservative way to financially help your child.
Inherited Assets: After tax vs. pretax
Helping our kids doesn’t have to happen just in their early years. At your death, you will have to pass on your assets to your kids. The asset and account type you pass on to your children will have an impact depending on your kids financial situation. For example, if your kids are in a higher tax bracket, they will want to inherit tax free assets. Or in other words, it would be in their best interest to inherit Roth IRAs as opposed to pre tax retirement accounts. This would require you to be more aggressive with roth conversions to get money out of your pre tax accounts and into Roth IRAs. The opposite is also true. If your heirs are in a low tax bracket, it might make sense to target your pretax accounts and spend your tax free assets in your later years.
Pros: Potentially less taxes paid overall between you and your kids.
Cons: Proactive tax planning needed (i.e., more work for you), little help for your kids in early years.
Inherited Assets: Amount to be inherited
Proactive estate planning can help your kids in particular situations. For example, if you (and your spouse if married) were to pass away, would you want your 18, 19, or 20 year old child to take possession of ALL your hard earned money immediately? Most people have estate plans that say exactly this. You could instead set up guard rails for your money and stipulate, for example, that your child only receive 10% of your assets at age 18, another 20% at age 25, another 40% at age 30, and so on and so forth. This would be a type of ‘trust fund’ for your child to ensure they don’t get 100% of your money upfront (preventing the purchase of a Ferrari on day 1…).
Pros: Provides guard rails for kids in their early adult years, more control over estate distribution to heirs.
Cons: Cost of initial estate plan and ongoing administration.
Inherited Assets: Estate Tax
In addition, estates that are subject to state or federal estate tax should be proactively planning with their estate planning attorney to discuss strategies to lessen their estate tax bill. Irrevocable trusts, life insurance policies, and gifting are all ways to lessen your estate and gift taxes. This will provide more after tax dollars for your estate and ultimately your children.
Pros: less taxes owed, more money for your kids
Cons: requires proactive planning, cost of initial estate plan and ongoing administration
The Paradigm Shift Takeaway
Whatever you decide to do: 529 college savings, UTMA/UGMA, custodial roth IRA, life insurance, etc: let your kids know NOW what your plan is. Getting your kids involved in the proactive financial decisions you’re making creates trust between you and your child and also begins their financial education at an early age. Families who are more open about their finances tend to be more successful financially. It creates openness and a sense of the entire family being on the same financial team. I know it isn’t easy discussing money with your kids, but the sooner you do this, the sooner your kids will become financially strong and independent. As always, reach out to me with any questions and. I’ll see you out there!