Build Wealth and Financial Literacy for your Children
You don’t have to be independently wealthy or rich to set your kids up for financial success. In fact, most parents with modest income can take steps early on to set their children on a path to wealth and financial acumen.
Each of your children should have (3) investment accounts:
-
529 College Savings Plan
-
Custodial Roth IRA
-
Custodial Brokerage Account
WHY? Besides the obvious idea of investing and saving, this is an opportunity to educate your children on the power of saving, compounding returns and fiscal responsibility.
Disclaimer: Everything discussed below is high-level and you should read up on each plan in detail and consult a financial expert with questions.
529 College Savings Plan
A 529 plan is a phenomenal tax strategy, because all of the gains over the life of the investment are not taxed.
The Cost of a 4-year university degree can vary greatly, but let’s assume $50,000 per year or $200,000.
I tell people to try to invest $500 per month per child from the day they are born. That is $6000 invested per year over 18 years. At a modest 6% growth rate that investment would grow to about $200,000. That works out to $108,000 of money invested that grows to $200,000, so $92,000 of appreciation (returns, gains, income, etc…) that the government will not tax.
Visually the assumptions above look like this:
- $6000/ year for 18 years at 6% growth.
- $108,000 invested.
- $92,000 return/income NOT TAXED.
Not all kids are destined – nor should they be – for 4 year college. This money can also be used for many trade profession and education/certifications programs:
- Electrician
- Plumber
- Carpenter
- Dental Hygienist
- Cosmetologist.
- The list goes on…
Lots of good info here if you want to read up more on 529s. I’ve also written on some of my personal experiences in the past:
Custodial ROTH IRA
A Roth IRA is a retirement account that you put after-tax money into, but when you draw on it in retirement the gains are not taxed. So similar characteristics of a 529, but for retirement.
If your child has earned income – and can be from babysitting, mowing lawns, etc, so not necessarily W2 income – then they or you as their parent can contribute up to their income or $7000 per year.
Just as working adults should be contributing to a 401k or IRA, this is a vehicle to enable our children to start saving for retirement before they head off to be adults on their own.
It’s called a “Custodial” because the parent controls the account until it is legally transferred to the child between ages of 18-25.
Let’s say you were able to contribute $5000 to their account from the age of 15 to 22 and average 8% annual returns. That investment would grow to ~$1m by the time they are 60 or $2.3m at age 70. Not bad! A parachute for your children.
Further this money is NOT TAXABLE because it’s in a Roth IRA.
The above assumptions look like this:
- $5000/ year for 8 years at 8% return.
- $40,000 invested.
- Over $1 million dollars to your child in NON TAXABLE income.
The chart above is a little crazy; had to check the math a couple of times. This is the power of compound interest!!
Custodial Brokerage Account
A “custodial” brokerage account enables your children – or you on their behalf – to invest money in Money Market Funds, ETFs, stocks, bonds, etc…. It’s basically the same as your brokerage account, except that you control it, until it legally passes to your child at age 18-25 (like the Roth discussed above).
So if your kids are earning money (or maybe you’re just gifting it to them), they/you can allocate some to the brokerage account and have a larger universe of investment options:
- Money Markets (earning ~5% in 2024).
- Short term Certificates of Deposit.
- US Government treasuries and bonds.
- Stocks, Mutual Funds, ETFs, etc…
Why? Many kids are earning money and it’s sitting in their checking account earning nothing. A simple 5% money market account would earn your kids an extra $500 per year on $10,000.
Finally, and very important, it’s a construct or mechanism to teach financial literacy to your kids.
LONG STORY SHORT: Invest now for your kids.
Bonus:
I was so blown away by the Roth returns, I was thinking what if your kid then gets a job and keeps maxing their contribution at the current $23,000/ year level through age 60 (which by the way is oversimplified and can be much higher with employer match, etc…).
Here is Roth from parents and 401k from kids:
- Roth at $40,000 from parents.
- 401k pre-tax at $23,000 per year until 60.
- $6-10 million for kids around age 60-65.
Note: You can’t even see the “Roth Investment” in pink in the chart above, because it is so small to the overall portfolio, but resulted in huge “Roth Earnings”.
In closing
I just want to emphasize that the ideas and discussion above is quite simplified and does not contemplate all sorts of technical rules nor tax assumptions. The numbers could be much smaller or much higher by changing assumptions.
The point is to highlight: You can create great wealth by simply starting early and being consistent. And it’s a great way to help your children attain financial literacy and independence!
