I am a mom of two little ones and like all parents I want my kids to grow up to be financially independent adults. Although my son Theo is only three and my daughter Harper just turned one, I think it’s never too early to start thinking about all the ways we can set our kids on a path toward success!
If you are willing as a parent to open financial accounts for your children while they are young, you are effectively laying the foundations of building wealth for your next generation. As Warren Buffet often says “it is not about timing the market it’s about time IN the market”. In other words, because of the power of compounding interest, time can do the heavy lifting if you plan accordingly.
Below are some accounts to consider opening for or with your children at different stages of their lives.
529 College Savings Plan
I think the very same day my son and daughter were born my dad opened a 529 college savings plan for each of them. Why? Well to start, a 529 plan comes with a wide range of benefits since they 1) grow tax free 2) the withdrawals are tax free and 3) there are no federal limits on contributions.
When it comes time for my kids to withdraw the money, they can do so tax-free for any education related expenses including tuition (not just limited to a four year college since funds can be used for vocational school, study abroad programs, online courses, graduate programs and all kinds of other programs), room and board, books and even some things you may not think of like computer technology and internet access expenses.
Another huge advantage of the 529 plan is that it is owner controlled so the account can be flexible and beneficiaries can change based on need. This means that if my children end up using only a portion of the funds, I could assign a new beneficiary with no penalty. Interestingly enough, I recently read an article about a husband and wife in their 60’s from New Jersey. They retired and enrolled in a program to study ecology and leather back turtles through a New Jersey community college course taught completely on the ground in Costa Rica! They tapped $25,000 in 529 savings to pay the bill. So while the original intention may be to help your children pay for college, they may end up using those dollars far into the future. Who knows what retirement might look like in the future, but if life-long learning continues to trend upward your kids could be using these 529 funds well past their collegiate years.
But really the point here is that if you open a 529 account when a child is born and commit to investing $2,000 every year until they graduate high school at 18, the account will have over $100,000 in it if they earn a 6% return. Open this account early and instead of buying toys that kids outgrow, break or tire of after just a few weeks, consider making contributions to their 529 plan, which will yield a tremendous amount in years to come.
MIDDLE SCHOOL YEARS (10-13 years of age)
Checking & Savings Account
Once a child starts doing chores around the house and is rewarded financially, I think it is time to consider opening a checking and savings account. Opening a checking account for your child is an invaluable teaching opportunity that allows you to practice things like budgeting and understanding the differences between revenue and expenses.
I read a really interesting article recently which advocates that parents should mimic real world financial conditions at home in order to teach kids these lessons from a young age. Instead of just giving your child a $20 bill for allowance, the article suggests giving them $100 of “income” and then creating a budget together with $80 worth of expenses such as rent, groceries and other items. You can then have your child write a check from their account or transfer the money into yours. If you start simple by tying their income to household chores and charging them, mock real-world expenses, then as they grow older, you can teach them more complex financial lessons like entrepreneurship and investing. Pretty great if you ask me!
We always talk with our clients about the importance of having an emergency fund of savings. It is important to start building these good habits at a young age. In addition to the checking account, why not open a savings account and have your child start setting aside a small percentage of their allowance each month. This money could be used to buy something extra special that they have worked hard to earn.
HIGH SCHOOL YEARS (14-18 years of age)
Micro Savings Accounts
If your child has his or her own checking account/ debit card, then they can open a micro savings account. With these services, you can save and invest the change from every purchase made with your debit card. For example if every day after school your teen buys a snack for $2.68, you can set the micro savings app to round up to the nearest dollar. That 32 cents (the difference rounding up to $3) will automatically hit their investing account. While that is a tiny amount of money, after 20 days a month, that amounts to $6 per month. That can add up over time, and they can invest that money for bigger gains.
Acorn is a really good micro savings app for teens because there’s no minimum amount required to start saving and it’s free for people under the age of 24.
Once your child gets their first job it’s time to open a Roth IRA. A Roth is really tailor-made for people whose tax bracket is likely to be higher when they need to take the money out, as opposed to when they’re putting it in. A teenager who is working as a lifeguard after school is likely going to have significantly less taxable income now than in their future.
For 2020, the maximum your child can contribute to their IRA is $6,000. Additionally, they must have “earned income” to be eligible to contribute; so unfortunately, being paid in cash as a babysitter will not qualify to contribute to an IRA. Earned income is general income reported on a W-2 tax form.
I know for some teenagers the idea of saving so much of their hard-earned money for the future is a tough sell. One way I have heard parents approach this is by contributing a percentage match to their teenagers IRA. Let’s say the lifeguard earns $3,000 over the summer. His parents allow him to make the decision how to spend the $3,000 but they also commit to put 50% of his earnings as a match into the IRA; in this case $1,500 and a 100% match on anything he willingly contributes to the IRA.
Even just a few years of contributions to a Roth as a teenager will lay the groundwork for building a significant nest egg when they reach retirement age. Keep in mind that Roth IRAs are extremely flexible so while they should ideally let their Roth IRA compound for retirement, the account leaves plenty of room for other uses if needed and after five years, they can withdraw with zero penalties.
Taxable Brokerage Account
At the same time as opening the Roth IRA, why not consider opening a taxable brokerage account for your teen. Since they are free and have no income requirements, this is a perfect opportunity to teach your child about investing. If the child is under 18, you would open a custodial account which gives the parent management control until the legal age in your state (each state varies but most, are 18-21 years of age) at which point the account’s ownership will transfer to the child.
Why not pick some stocks together based on their interests? Does your son love his Apple phone, Nike shoes and videogames? Is your daughter a Netflix loving fashionista who frequents the local Starbucks? Consider working together to purchase some fractional shares in companies they know and love that meet their interests and let them become engaged in following the performance. This is a great time to show your teen how to use stop orders and limit orders to trigger purchases and sales. With this account the expectation is not that it will be a major source of savings or income but instead an opportunity to teach your child about the process of investing.
If you are interested in opening this kind of account I recommend checking into Fidelity’s zero fee accounts. They are particularly good for this purpose because they have no minimums, no service fees, and no trading fees.
I think every parent just wants what is best for their child and to help set their next generation on the path towards financial stability. Take some time to consider implementing some or all of these strategies and remember that it’s always wise to consult your trusted financial professional to talk more about these options since they are focused on your individual and familial situation.
I would love to hear from you and how you are thinking about helping your own children with their financial well being! At Bloom Asset Management we are always happy to advise and help our clients to open these accounts for their children or grandchildren.
Please feel free to email me at firstname.lastname@example.org