Making your child a millionaire
In this ever-changing economic landscape, securing the future for our children has never been more critical. It's not just about ensuring they have a good life; it's about empowering them to lead exceptional lives, free from the constraints of financial worry. It's about creating a legacy, a safety net woven from the threads of sound financial planning, smart investments, and strategic decision-making. In this blog post, we are not just discussing financial strategies; we are delving into the art of building a dynasty, a legacy that stands the test of time.
We understand the dreams you have for your children, the aspirations that keep you awake at night, and the determination to provide them with opportunities beyond your own reach. In this week’s blog, we’ll discuss four ways you can proactively save and invest for your kids. Let’s dive in!
529 Plan: Your education fund
A 529 plan is a tax-advantaged savings plan designed to help families save for education expenses. Contributions to a 529 plan are made with after-tax dollars, but earnings grow tax-free and withdrawals for qualified education expenses are also tax-free. Different states have their own 529 plans, and each plan has its own investment options and rules.
The average cost of a private university today is $38,000. If we assume this grows by 3% inflation per year, the cost in 18 years would be $270,648 total for four years, or an average cost of $5,639 per month. We absolutely recommend starting to save early for college, because that is a hefty cost to float! How much would you need to save to do so? Investing less than $8,000 per year or $665 per month at a 7% rate of return beginning when they are born will get you there!
A lot of parents worry that they will save too much money in a 529 plan. We agree that piling too much money into a 529 plan might not be the best strategy, because your child might get a scholarship for college, choose a less expensive option, or decide not to go at all! The good news is that the Secure Act 2.0 has created a new tax law that enables parents to convert up to $35,000 into a Roth IRA. We covered this new tax law in great detail in this blog post. The better news is that there are more ways than just a 529 Plan to save!
UTMA: Like a taxable brokerage, but for a child
Uniform Transfers to Minors Act (UTMA) refers to a law that allows a minor to receive gifts without the aid of a guardian or trustee, including money, patents, royalties, real estate, and fine art. If you provide gifts to an UTMA for your child, it shields them from tax consequences on the gifts, up to a certain amount. Under IRS rules, for 2023, the first $1,250 of a child's unearned income (dividends, interest and capital gains) is earned tax-free, and the next $1,250 is taxed at the child's rate. Anything over $2,500 for 2023 (up from $2,300 for 2022) is taxed at the parents' tax rate instead of the child's generally lower rate.
UTMAs are like taxable brokerage accounts, which become the child's account upon reaching the age of majority (18 or 21, depending on the state). The positive is that the money can be used for anything, the drawback is that it is a taxable account, and could negatively impact the child's financial aid during college if they decide to go.
Let’s assume you start contributing to this account at $1,000 per year. Over 18 years, you will have contributed $18,000. By age 18, if the account grew by 7% per year, their investment would grow to nearly $34,000. If they waited until age 35 to use the funds, it would grow to over $107,000. If they waited until age 65, it would grow to over $800,000!
Taxable Brokerage Account: It’s yours, but it’s earmarked
Perhaps you’re unsure about gifting at this stage, wanting more financial security, and the flexibility to oversee your child’s future funds. A taxable brokerage could be the right choice! If you’re unfamiliar with a brokerage account, we wrote a great blog on this type of account here. Taxable brokerage accounts are investment accounts in which you invest your cash-money into securities like stocks, bonds, mutual funds and exchange-traded funds. Taxable accounts house your assets that are not earmarked for your retirement.
In practice, you’re opening an account in your name, and dedicating these funds (not formally, but rather as a plan) to your child. The benefit is that you have flexibility to ‘undo’ this gift, as it isn’t actually a gift as the funds remain in your name. You won’t have to worry about a kiddie tax if your investments grow, but you will pay taxes on any income generated by the account. This is the main downside - your tax bracket is almost certainly higher than your child’s tax bracket. However we can’t put a price on flexibility and peace of mind, so it’s a reasonable strategy to deploy!
Let’s assume you start contributing to your child's taxable brokerage account at $2,500 per year. Over 18 years, you will have contributed $45,000. By age 18, if the account grew by 7% per year, their investment would grow to nearly $85,000. If they waited until age 35 to use the funds, it would grow to nearly $269,000. If they waited until age 65, it would grow to over $2 million!
Custodial Roth IRA: Your child’s retirement fund
A Roth IRA is a retirement savings account that allows you to contribute after-tax dollars and withdraw money tax-free in retirement. A Custodial Roth IRA has the same structure, but it’s for a minor! As long as you have earned income, you’re allowed to contribute into Roth IRAs. They have income limits, contribution limits, and other restrictions, but they are a popular retirement savings vehicle for people who expect to be in a higher tax bracket in retirement than they are now. As a child, that’s a pretty safe bet!
In order to contribute to a Roth IRA, you must have earned income. Can a child have earned income? While it’s uncommon, there are a number of ways that a child can earn income:
Modeling & acting: Children who work as models or actors in commercials, TV shows, movies, or other entertainment productions earn income, which is taxable.
Entrepreneurship: Children can start their own small businesses, such as lawn care services, pet sitting, or selling handmade crafts. The income generated from these businesses is taxable.
Social Media and YouTube: Some children earn income from social media platforms, YouTube channels, or other online content creation. Revenue generated from ads, sponsorships, or merchandise sales is taxable.
If you are a business owner, you might consider employing your child. While it’s a lot of work, the benefits can be huge, as you receive both a business deduction, and your child receives tax free income and growth on investments over the long run. Parents are generally permitted to employ their own children in their businesses, provided the employment is legitimate, the child performs real work, and the compensation is reasonable and in line with industry standards. It's crucial that the child is of legal working age, capable of the assigned tasks, and that the work performed is necessary for the business's operations. Additionally, documentation is required including hours worked, duties performed, and payments made. We absolutely recommend working with a tax professional or legal advisor to ensure compliance, as laws and regulations can change over time.
Let’s assume you start contributing to your child's Custodial Roth IRA at $6,500 per year, the current maximum for this year. Over 18 years, you will have contributed $117,000. By age 18, if the account grew by 7% per year, their investment would grow to nearly $221,000. If they waited until age 35 to use the funds, it would grow to nearly $700,000. If they waited until age 65, it would grow to over $5.3 million!
Nurturing Generational Prosperity
Now that you understand the accounts, let’s bring it all together. It’s hard to believe, but investing less than $1,500 per month for your child can result in a fully paid for private college education in addition to over $1 million in investments by the time they reach 35 years old, and over $8 million by the time they retire! We’ve included a summary table below for your reference.
Note: All values are approximate and calculated based on assumed yearly contributions until age 18 and a 7% annual return from age 0 to 65. This assumes no withdrawals are made at any time before the age of 65 is reached. These figures are for illustrative purposes and may vary based on market conditions and individual investment decisions.
The above strategy works, because we’ve kept limits in mind. As of the time of this writing, you may give up to $17,000 per year to a child without filing any gift tax return, and a child may earn up to $13,850 in income without paying taxes. It’s important to keep limits in mind, and we recommend working with a tax professional and estate planner to ensure you structure your legacy planning in a way that aligns well with current tax regulations.
Remember, building generational wealth isn’t just a fiscal goal; it’s a testament to your dedication as parents, your foresight, and your unwavering belief in the power of possibility. The strategies we've explored aren't merely financial instruments; they are tools to craft a tomorrow where your children, and their children after them, can thrive.
As you delve into these strategies, remember the deeper purpose—they're not just financial decisions; they're investments in the stories your family will tell for generations. As you navigate this path, be proud of the legacy you're building, the future you're shaping, and the lives you're transforming.
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Stephanie Bucko and Cristina Livadary are fee-only financial planners based in Los Angeles, California. Stephanie is the Chief Investment Officer and Cristina is the Chief Executive Officer at Mana Financial Life Design (FLD). Mana FLD provides comprehensive financial planning and investment management services to help clients grow and protect their wealth throughout life’s journey. Mana FLD specializes in advising ambitious professionals who seek financial knowledge and want to implement creative budgeting, savings, proactive planning and powerful investment strategies. As fee-only fiduciaries and independent financial advisors, Stephanie and Cristina never receive commission of any kind. Stephanie and Cristina are legally bound by their certifications to provide unbiased and trustworthy financial advice.