America is currently facing a significant affordability crisis. From 1980 to 2023, the costs associated with college tuition, fees, room, and board have skyrocketed by an astounding 885%, not factoring in inflation. Concurrently, the average price of homes has surged by 577%, leading to a growing number of individuals who are uncertain about their ability to retire comfortably. This alarming trend highlights the urgent need for proactive financial planning.
With the worsening of these financial conditions showing no signs of improvement, it has become increasingly essential for parents to explore every feasible option to effectively prepare their children financially for a future that is likely to be marked by higher costs. Taking the right steps now can make a significant difference in ensuring financial security for the next generation.
Fortunately, building generational wealth does not require a millionaire’s fortune. Whether you start by investing as little as $100 a month or as much as $1,000, what truly matters is to take that first step. The well-known adage states that the best time to invest was ten years ago, but the second-best time is undeniably right now. Delaying your investment decisions can lead to missed opportunities that could have long-lasting impacts on your family’s financial future.
This principle is rooted in the time value of money, which asserts that a dollar today holds greater value than the same dollar in the future due to its potential to earn. In simpler terms, postponing your investments now means forgoing significant growth later. By taking into account the power of compound interest, the potential earnings for your children over several decades can be exponential, creating a strong financial foundation for their lives.
To aid in securing your children’s financial futures, consider these three powerful financial tools.
Maximize Growth with a Custodial Brokerage Account
Custodial brokerage accounts are investment accounts specifically designed for minors, managed by adults. While they do not offer tax advantages, they come with numerous benefits that can help parents secure a brighter financial future for their children. According to Hillary Stalker, executive vice president and financial advisor at CapWealth, these accounts are an excellent way to save.
“Saving money for your children in any way, shape, or form is never a bad thing,” she emphasizes. “If the aim is to save for significant expenses like a car or a home, these accounts provide a wider array of investment options than traditional savings accounts.”
Major online brokerages typically offer custodial accounts; however, parents should remain aware of the tax implications, particularly concerning the “kiddie tax.” This tax was introduced to prevent wealthier families from shifting assets to their children to benefit from lower tax rates, but it applies to all tax brackets, affecting income-producing assets.
According to investment firm Charles Schwab, the kiddie tax applies to dependent children under 18 years old or full-time students younger than 24, and includes the following rules:
- The first $1,350 of unearned income is exempt from taxation due to the kiddie tax’s standard deduction.
- The next $1,350 is taxed at the child’s marginal tax rate.
- Income exceeding $2,700 is taxed at the parents’ marginal tax rate.
Any gains from stocks or ETFs in a custodial brokerage account are not subject to tax until the assets are sold. However, any dividend income generated from these investments will be taxed in the year the distributions occur.
Parents can utilize custodial brokerage accounts to accumulate funds for their child’s future, providing versatile options that are especially beneficial for families uncertain about educational paths. Additionally, Stalker refers to these accounts as having “training wheels” for investing; once your child reaches adulthood, the account transitions to their name, allowing them to learn about investment management and the importance of responsible financial stewardship.
Empower Your Child’s Future with a College Savings Plan
For parents who envision college as part of their children’s futures, establishing a college savings plan can be a critical financial strategy. Given the soaring costs of education, even families with higher incomes often find it challenging to save adequately.
A study by admissions consulting firm Spark Admissions surveyed 200 families with incomes exceeding $200,000 and children aged 13 to 17. The results revealed that only 44.7% of these families have saved or plan to save $100,000 or more for college. This figure falls alarmingly short of the average four-year cost of college tuition, fees, room, and board, which totals approximately $110,692.
This is where the 529 college savings plan comes into play. “The flexibility of 529 plans has significantly increased over time,” says Stalker. “In today’s dynamic educational landscape, a 529 plan provides tax-free growth that can be used for various educational expenses.”
Qualified educational expenses encompass a wide range of costs, including school housing, meal plans, textbooks, computers, software, study abroad, and transportation. Moreover, there are provisions for paying interest or principal on qualified educational loans, up to a lifetime maximum of $10,000 for each designated beneficiary and their siblings.
“The scope of 529 plans has broadened tremendously,” Stalker explains. “They can now be utilized for private education during earlier schooling years, trade schools, traditional universities, and the various expenses associated with college education, including funding a Roth IRA.”
This last aspect is particularly significant. While withdrawing funds from a 529 plan that remain unspent on qualified educational expenses typically incurs a 10% federal tax penalty, the SECURE 2.0 Act of 2022 allows for a special provision. This enables individuals to roll over up to $35,000 into a Roth IRA tax-free, which presents a tremendous advantage for those concerned about excess funds in their 529 plans.
“This new rule offers a way to transfer funds to a Roth IRA without tax penalties, providing peace of mind for those worried about leftover 529 plan money,” says Stalker.
It’s important to note the following conditions for this rollover:
- The 529 plan must have been established for the designated beneficiary for a minimum of 15 years.
- The Roth IRA must be opened in the name of the beneficiary of the 529 account.
- Annual contribution limits apply to the amount transferred from the 529 account.
- The transferred funds must derive from contributions made at least five years before the rollover date, and the total amount rolled over cannot exceed $35,000 per beneficiary.
Unused funds from a 529 plan can also be redirected. If your oldest child does not utilize all the funds or opts not to attend college, those remaining assets can be allocated to the next child. Similarly, grandparents who open a plan can use the funds for another grandchild, thus ensuring that the financial resources benefit the family as a whole.
While 529 plans do not impose federal contribution limits, each state sets a lifetime cap ranging from $235,000 to $575,000.
Give Your Child a Financial Advantage with a Roth IRA
Among non-retirees, a staggering 66% of Americans feel they are falling behind on their retirement savings. To give your child a head start in this area, consider setting up a custodial Roth IRA, which can be funded long before the potential rollover of funds from a 529 plan becomes necessary.
Similar to custodial brokerage accounts, custodial Roth IRAs can be established as soon as your child starts earning income. This could stem from various activities such as dog walking, babysitting, or summer jobs. The essential requirement is that they must be earning income and paying taxes on it.
Annual contributions to a custodial Roth IRA are capped at $7,000 or the total income of the child, whichever is less. For instance, if your child earns $2,500 in a year, you can contribute up to that amount to their account on their behalf, allowing for significant growth potential.
Custodial Roth IRAs, much like custodial brokerage accounts, provide a wide range of investment options. Funds placed in these accounts grow tax-free, just like 529 plans, as long as withdrawals are not made before the child turns 59½ and the account has been open for at least five years. Ownership of the Roth IRA transfers to the child upon reaching adulthood, empowering them to take charge of their financial future.
“There’s no one-size-fits-all approach to saving,” Stalker concludes. “Ultimately, it comes down to your personal goals and financial aspirations.”
Instill Financial Literacy Through Teachable Moments
Another significant advantage of opening any of these investment accounts for your children is the opportunity to model healthy financial habits. By engaging them in discussions about their accounts and the principles of saving, you can lay the groundwork for their future financial success.
While children may have an innate tendency towards immediate gratification, teaching them about the benefits of compound growth can cultivate a sense of patience and perseverance in their financial dealings. Understanding that investments take time to mature is a vital lesson that will serve them well throughout life.
“Children, like many adults, often gravitate towards instant gratification,” remarks Nate Hanft, senior vice president and financial advisor at Wealth Enhancement. “Creating an environment that encourages delayed gratification fosters the discipline necessary for financial success.”
By utilizing these accounts, Hanft emphasizes that parents can help their children develop sound financial habits by actively involving them in financial goals, highlighting the importance of saving, and instilling a sense of responsibility. These elements are crucial for children to comprehend the value of money and to set the stage for future financial independence.
“It’s widely recognized that children often replicate the behaviors they observe,” Hanft adds. “Financial habits are no exception to this trend.”
Explore Valuable Financial Insights with More from Money
Discover the diverse range of over 12,000 ETFs available. Which one aligns perfectly with your age and financial goals?
Stay informed with our Congress Stock Tracker: Unveil the most active traders’ purchases as they enter 2025.
Gain insights into the future with our predictions for the stock market in 2025.
