Among the wealthiest American families, the average inheritance can be between $700,000 and $1 million. But passing on wealth isn’t exclusively the provenance of the extreme rich. Funneling even modest amounts into the right financial vehicles now can help educate the next generation on financial principles and give them a leg up in a world where wealth transfer is increasingly important. Our expert Jill Garvey shares strategies for helping younger family members start with more (and manage it wisely) when they become adults.
Custodial Roth IRAs give kids a head start in the market
Teenagers might roll their eyes when you start talking about saving for retirement, but putting away a little money really early on can be an incredible advantage down the road. Not only does an early start allow for interest to compound over decades, it also gives kids the chance to start exercising their “savings muscles” so that by the time they get their first full-time job, putting away some money for retirement will feel natural.
“I always recommend to clients who have teenage children, let’s say around 13-14 years old, to talk to them about contributing to a Roth IRA if the child has earned income,” shares Garvey.
To open a custodial Roth IRA, the young person will need to have a job with a W-2 to show they are paying the appropriate taxes. For a little extra motivation, you could match what the young person contributes, up to the allowable yearly limit, currently $7,000.
How it works
Any responsible adult can open a custodial Roth IRA on behalf of a minor. It doesn’t have to be a parent. So you can set one up for nieces and nephews, grandchildren or godchildren, for example. When the child becomes an adult, at either age 18 or 21 depending on state law, the account is transferred into the name of the child, with absolutely no tax implications.
529 plans are a smart play for covering education costs
It’s pretty much never too early to open one of these tax-advantaged accounts that exist to help young people pay for their education when the time comes. Garvey recommends starting these accounts when kids are very young, even infants, through middle-school age. “However, if someone’s 17, we probably aren’t going to start funding a 529 plan at that point,” she explains.
Setting aside money for education can be particularly appealing to grandparents. “Depending on their level of wealth, grandparents may be looking for ways they can reduce their exposure to estate tax, and if education is a value in the family, a 529 can be an effective and efficient way to provide for or contribute to advanced education for my family,” explains Garvey.
For those who may have significant amounts to gift, and want to maximize the compounding power of their money, consider what’s called “superfunding.” Basically, one person can front-load five years of money all at one time into the 529 plan. Currently, that’s $18,000 multiplied by 5. “If I’m grandma and grandpa, they could put up to $90,000 in at one time,” says Garvey. This method gives the money more time in the market, so it can grow earlier and faster. That can make a big difference for long term college savings.
How it works
Anyone can open a 529 account on behalf of any young person, as long as they have the child’s name, date of birth and social security number. The money can be used tax free for college, university, trade school, apprenticeships or grad school expenses, including tuition, books, computers and required software. Up to $10,000 per year per child can be used to pay for K-12 tuition. Additionally, you can use up to $10,000 total from a 529 plan to repay a student loan. And if there’s any money left after schooling ends, you can rollover the funds into a Roth IRA, limited to annual contribution limits and a ceiling of $35,000.
Trusts are not just for the uber rich
A trust may seem like a fancy legal arrangement you only need if you’re filthy rich, but the truth is middle-income families may benefit even more from having one in place. In the simplest terms, a trust lets you create rules for how your money is handled. You can spell out in your trust how and when money gets passed down, avoid court involvement and keep your home out of probate, which can cost from $3,000 to $10,000.
“A trust serves several purposes,” explains Garvey. “Tax efficiency is only one aspect. Avoiding probate by having a trust is a very important aspect because probate can be expensive and time-consuming. It’s also open to the public. People want their financial affairs kept private, and that’s another benefit of having a trust,” she continues.
Trusts can also be useful if someone should become disabled, since they name a trustee who can seamlessly take over your financial affairs if that’s needed.
How it works
Work with a lawyer to draft paperwork for a revocable living trust, naming the grantor (you), the trustee (the person managing the trust) and the beneficiaries (who receives the assets upon your death, many times children). Then sign the trust in front of a notary and transfer assets into the trust. This is the most important part. To make the trust actually work, you’ll transfer your home title to the trust, change bank accounts so the trust is the owner, move non-retirement investment accounts into the trust and update beneficiaries on retirement accounts and life insurance.
Stocks can be child’s play
Giving young people shares of specific stocks can be a way of making the market feel more tangible and accessible. “We’ve had clients who have treasured certain stocks, whether their grandparents worked there or it was just significant to their family in some way,” says Garvey. You can show even a really young child the stock you purchased for them, and invite them to check in on it with you on the computer screen or app over months and years. When they legally become adults, you can gift them their stock for them to decide whether to cash it out or continue to monitor it.
This kind of gift can spark a newly minted adult’s curiosity to play around and understand how the stock market really works. Instead of waiting until they “have enough” to get started, they’ll be ahead of the game by jumping in with both feet. “As long as it’s not the only way you transfer wealth, it’s a nice piece of the puzzle,” says Garvey.
How it works
Buy stock on behalf of a child in your own brokerage account, informally earmarking it to be given to him or her later. Then you can transfer the shares as a gift when the child becomes an adult. Or you can create a custodial brokerage account for a more formal arrangement.
Custodial brokerage accounts transform kids into mini stock traders
While minors can’t technically trade stocks on their own, opening a custodial brokerage account in their name is the next best thing. Set your junior trader up next to you and explain the options within their UGMA, or Uniform Gifts to Minors Act account. You can even let them direct money movement, as their understanding grows.
Alternatively, just knowing about the account is many times enough to keep it at the top of a young person’s mind. “My daughter will get money at Christmas or on her birthday, and she’ll come and give me the cash and say, ‘Put this in my investment account,’” shares Garvey. It’s a hands-on lesson in the importance and power of investing. “Investing is what gives you financial security,” explains Garvey. “Investing could get you 8 or 10% or more, versus historical money market rates which are much lower,” she continues.
How it works
Opening a UGMA account online is just like opening a normal brokerage account, but with the child listed as the owner and an adult as the custodian. Then fund the account and start investing. At the “age of majority,” either 18 or 21, depending on the state, the account is legally turned over to the child and they get full control.
Impart wisdom along with wealth
Along with giving young people a head start on their way to financial freedom, all of these options work best when accompanied by a solid dose of communication. “Our clients we’ve seen successfully transfer wealth, the common theme is that they made sure that family communication was paramount in their home,” observes Garvey. “They also made sure that the children, when appropriate, were given the ability to weigh in on decisions such as when they were earning income as teenagers.”
All of these lessons, compounded over time, add up to empowerment. “These parents empowered their children to become thoughtful and mindful as they moved on with their lives and became adults,” says Garvey. “To think critically about how they are spending their money on needs, wants and wishes. Making an impact on the community and investing for financial independence.”
Starting somewhere is the important thing, rather than waiting until you have “enough” to get started.
