Even the most financially comfortable and optimistic clients can be afraid for the future of their child. But a lot can be accomplished for the kid for a relatively small amount of money, as long as the clients start saving now.
Here’s how parents, grandparents and other adults fond of a certain child can provide a lifetime of financial security and prosperity for the kid by saving no more than $1,000 per month, and only until the child reaches adulthood. And for those clients who can’t save that much, any amount saved sooner rather than later is better than none at all.
Note that the investment calculations below are made using a 6% hypothetical annual rate of return, unless noted otherwise.
Buy Term Life Insurance
Most parents either don’t have life insurance, don’t have insurance with a sufficient death benefit or have purchased a group policy at work instead of on their own.
Although this group is highly unlikely to die before their children reach adulthood, their death (and the inherent loss of income and/or caregiving abilities) could wreak a financial tragedy on the children and the surviving spouse, to go along with the huge emotional toll.
Cost According to the website Term4Sale.com, a 30-year-old in good health can get a $1,000,000 25-year term policy for $45 per month for a male and $40 per month for a female. That totals out to about $28,500 over 25 years.
Save for College
Parents of young children may still have their own student debt to pay off before they can worry about their kids’ future college costs.
But that debt can provide the parents with an extra incentive to begin saving for their child’s higher education expenses, especially using any funds available above the minimum monthly loan payment amount and/or when the loans are paid off.
The family doesn’t have to save up enough for the whole college cost out of pocket. Even covering one year’s worth of school through a 529 plan will make it less likely that their child will have to borrow any (or much) money to pay for a higher education.
Cost Assuming a $25,000 current cost for a year of college and a 3% annual increase in that amount, clients would have to save about $440 per month for 18 years to cover the $172,000 cost of four years of school. Even over 18 years that $95,000 total sounds like a lot, but having to borrow that $172,000 at 6% interest would require the kid to make monthly payments of over $1,900 to pay off the debt within 10 years.
Fund a Fund (Or Annuity)
Some benevolent clients might want to save and invest for a child, but prefer that the child have more flexibility in using that money than tools designed to save specifically for college or retirement will allow.
A regular stock-based diversified mutual fund is a suitable instrument for this purpose. Clients who are concerned about the tax cost and headache of dealing with unneeded fund distributions should consider a fund that is designed to minimize taxable events.
If the fund is for the benefit of a minor (usually one under age 18 to 21, depending on the state), the clients should use a Uniform Transfers to Minors Act designation, along with the minor’s Social Security number.
However, this arrangement has several possible drawbacks, including tax complications, a reduction in need-based financial aid for college and the child getting total control of the funds upon reaching “adulthood,” an age determined by the state in which the minor resides (rather than the beneficiary’s wisdom and maturity).
If these negatives are a concern for the clients, they may instead want to open the account in their own names and Social Security numbers, and then “gift” some or all of the account to the child when the time is right.
Clients who prioritize retirement savings for their child and want to avoid the tax and financial aid hassle of a mutual fund may want to instead fund a tax-deferred variable annuity.
The annuity will shelter any earnings from taxation, and the asset might not be included in future calculations for need-based college aid. However, any withdrawals of earnings before the child turns 59 ½ may be hit with a 10% penalty, plus income taxes.
And all other variables being equal, the variable annuity is likely to have higher internal expenses than the mutual funds, leading to lower net returns for the investor.
Cost If the clients deposit $166 per month into the investment account from the child’s birth to age 18 (and then stop), by the time she turns 65 that account would be worth $1 million. That works out to about $38,500 over 18 years.
Open a Roth IRA
The Pew Research Center says that only about a third of 16- to 19-year-olds have jobs during a particular year, but those who do can reap substantial benefits beyond the pay and work experience.
Their pay allows them to make contributions to a Roth IRA, for the lesser of their earnings or $6,000 for 2019 and 2020 tax years.
The kids don’t necessarily have to part with their hard-earned wages. Benevolent friends and family members can make the contributions for the kids, although it then becomes a gift to the kid and he can do whatever he wants with it.
A Roth IRA for a teen is usually better than an IRA, since the teen’s income is so low, he usually won’t have any tax liability. And the contribution portion of the Roth IRA can be withdrawn at any time for any reason, with no taxes or penalties whatsoever.
Cost Contributing $5,000 to the kid’s Roth IRA each year from age 16 to 19 (four years’ worth would be $20,000), and then having it earn a 6% hypothetical annual rate of return would give him about $355,000 when he turns 65—tax-free.
And hopefully planting the proverbial retirement-savings seed will encourage him to save his own money once he can afford to do so.
Kevin McKinley is principal/owner of McKinley Money LLC, an independent registered investment advisor. He is also the author of Make Your Kid a Millionaire (Simon & Schuster).