There are specific financial products and special considerations for planning and investing when there are children in our lives, including grandchildren, nieces and nephews, or other children with whom we have a personal connection. These may start at the birth of a child and continue to the time in our lives when we are planning our legacy.
Often the first financial product new parents purchase is life insurance on their own lives to provide financial protection for their children. Typically that is term insurance, which is affordable and can be timed to cover the years until children are in the working world and providing for themselves. Your insurance agent can help you determine what type of policy and how much to buy.
It is never too early to start to put away money for college. Fortunately for college savers, there is a very tax-efficient vehicle for that—the 529 plan, which can grow untaxed and from which money can be withdrawn tax-free for qualified education expenses. Each state offers a program, although one need not reside in the state that sponsors the plan selected. If your state offers a state tax deduction, you may want to use your own state’s plan, but other than that, you can choose a state plan based on the costs and investment options offered. Grandparents who want to help should be aware that starting in the 2024-2025 school year, qualified distributions from a grandparent-owned 529 plan no longer must be reported on the FAFSA, the form most colleges require for financial aid applicants. The website savingforcollege.com is a useful resource for researching 529 plans.
Retirement Plan Beneficiaries
Children can be named as primary or contingent beneficiaries on retirement plans, such as IRAs and 401(k)s. Typically, one’s spouse is the primary beneficiary, with the children named as contingent beneficiaries, who will inherit the money if the primary beneficiary is no longer alive. However, there are family situations that may be better served by alternatives to that arrangement, and an estate planning attorney should be consulted. When naming beneficiaries, you may also want to add a per stirpes designation, which will allow the inheritance to pass on to the named beneficiary’s children if the named beneficiary is no longer alive.
Teaching Children About Money
Today’s financial products are more numerous and complex than ever. The sooner that children can be taught to be responsible with money and how to evaluate financial products, the better. For children as young as three, there are picture books that introduce basic principles of money in an easy-to-understand way. If given a simple savings account or a certificate of deposit (CD), children can learn first-hand about the basic investing concept of compounding interest. Parents can use a child’s familiarity with everyday products to explain that through stock ownership, any of us can own a piece of a company like Apple or McDonalds. Many financial websites have features that let you design and track a “fantasy” portfolio without using real money. To enable a child to personally experience the ups and downs of the stock market, a small brokerage custodial account, with an adult as custodian, can be opened and invested in companies the child knows and likes. Fidelity offers a “Youth Account” for 13 to 17-year-olds, that has no minimum balance or account fees and lets the parent oversee the teen’s activity.
Once a child begins earning taxable income from an after-school or summer job, a Roth IRA can be opened. If the child is a minor, the account can be a custodial Roth IRA. The Roth’s earnings and qualified withdrawals are tax-free, and contributions (but not earnings) can be withdrawn tax-free if the money is needed at any time.
The maximum amount that can be contributed to a Roth in 2023 is $6,500, but it cannot be more than the child’s earned income for that year. Whatever the amount, it can be valuable as a teaching tool and as an important first step in saving for retirement. It won’t be long before the child may be asked not only how much they want to contribute to their 401(k) or 403(b) plan, but how it should be invested. For most people, the days of an employer establishing a pension plan, funding it, and deciding how to invest the money are long gone. Now that responsibility has fallen on the employees themselves, and your child will someday be among them.
If children are your intended heirs, it is a good idea to understand how certain types of assets are treated upon inheritance. For example, while a spouse can inherit your Traditional IRA or 401(k) and treat it as his or her own, a child as a non-spouse beneficiary must withdraw the entire amount over ten years and pay income tax on the withdrawals at their personal tax rate. If the withdrawals are large enough, they could push the child into a higher tax bracket, possibly at their peak earning years. Therefore, it’s usually more tax-efficient to leave Roth IRAs or non-retirement accounts to children. The cost basis of a stock or other security in non-retirement accounts is “stepped up” to the market value as of the date of death, which zeroes out any capital gain up to that point.
If your estate is large enough that it might be subject to either federal or state estate taxes, you can gradually remove assets from your estate by gifting up to $17,000 (in 2023) annually to each of your children and/or your grandchildren without being required to report the gifts on your tax return. The federal estate tax exemption is currently $12.92 million per person and will increase with inflation through 2025, but in 2026 it is scheduled to be cut in half with the expiration of the 2017 tax law, unless Congress votes to retain the higher amounts.
As always, if you have questions about investing for kids, you can reach us any time at (833) 888-0534 x2 or [email protected].
The views and information contained in this article and on this website are those of West Branch Capital LLC and are provided for general information. The information herein should not serve as the sole determining factor for making legal, tax, or investment decisions. All information is obtained from sources believed to be reliable, but West Branch Capital LLC does not guarantee its reliability. West Branch Capital LLC is not an attorney, accountant or actuary and does not provide legal, tax, accounting or actuarial advice.