By: Gaby S. Dominguez
Confident Kids℠ is a newsletter dedicated to helping parents and grandparents educate the next generation of young investors in the family how to think about money, i.e., how to save, how to invest, and how to become financially responsible as children, teenagers, young adults, and eventually as parents.
“The earlier, the better” is a popular refrain that is vital in accumulating wealth over time, as it harnesses the power of compound interest i.e., “interest on interest.”
Parents dream of financial independence for their children. To that end, many shell out big bucks for the best education money can buy. A quality higher-education, from a respected university often translates into a well-paying, post-college career. All too often though, parent’s stop short of educating children on how to save and invest at an early age.
When you are a parent, you want your children to have the most financial success possible. Therefore, influencing them to take steps to save, as soon as they begin earning income, will benefit their future finances even further.
The first step that your child can take, once they’ve started earning income, in high school or college, is to fund an Individual Retirement Account, specifically a ROTH IRA, once they have “earned income.”
As a parent, you may be constantly stressing over how to ensure your children’s future overall success and what next steps to take.
The basic principle needed to improve one’s financial literacy is grasping the overall concept of saving and how to implement it into your own life. Therefore, the use of an Individual Retirement Account, or IRA, becomes more than ideal for opening the door to opportunity for your child’s financial literacy.
An Individual Retirement Account, or IRA, is a retirement savings account that is typically funded with pre-tax dollars depending on one’s income. Introducing an account like this into your child’s life will add to their understanding of saving and investing for their future.
To re-emphasize, it is extremely important to begin this process with your child earlier rather than later, as they will benefit more from the reinvestment of dividends and interest earnings over time, along with the power of compounding.
Embarking on this journey with your child will put them on the path toward financial independence!
When your child is old enough to legally work, your children can contribute their earnings to an Individual Retirement Account (IRA), if they have earned income. Opening an IRA account is the first opportunity for your child to take their financial literacy to the next level. They are creating a tangible connection between money earned, money saved, and money invested, with a goal of generating more money for the future, instead of spending it.
Since there are different kinds of IRA accounts, there is a need for evaluating the various factors provided and how each type works overall…
In general, the ROTH IRA option is utilized more commonly for children as they are likely in a zero-income tax bracket and don’t need the tax break by making a deductible contribution to a pre-tax IRA. Unlike a Traditional IRA account, a ROTH IRA is funded with after-tax dollars. Lastly, withdrawals for ROTH IRAs are tax-free and penalty-free after five years, or after the age of 59½.
When opening a ROTH IRA for your child, the adult maintains control of the account until the child reaches age of majority, when control of the account can be transferred from the guardian to the child. In this case, the account will be initially established as a custodial account.
Custodial accounts are commonly opened as a Uniform Transfer to Minors Act (UTMA) or Uniform Gift to Minors Act (UGMA – only used in South Carolina). In some states, the UTMA account age of majority may differ from the legal age of majority, which is 18. For example, in Maryland, the UTMA account age of majority is 21. However, in Virginia, it is age 18, but there is an option to change it to either 21 or 25. In Washington, D.C., the UTMA account age of majority is 18 or 21. These options allow the custodian, or parent, to manage the funds until the minor is fully prepared to manage it themselves.
Your child can contribute up to $6,000 per year, or the total of a child’s earned income for the year, whichever is less. These contributions must come from earned income generated from activities such as, yard work, washing cars, babysitting, cleaning homes, selling lemonade, or caring for or walking pets.
In addition to getting a traditional job at places like McDonalds’ or Chipotle, earned income can also come through helping family businesses. For example, if you own a small business, have your child assist you by fulfilling tasks such as filing and shredding paper, bookkeeping, or social media management.
Parents can also contribute to a ROTH IRA for their child, which is commonly known as “parental matching.” As an example, if your child earned $1,000 this year and decided to spend $225 on clothes, video games, and other wants, they could contribute $775 of the money they earned into their ROTH IRA, while you can make up the $225 difference, if you choose to.
If you believe that you and your children are prepared to take on this financial voyage together, then there are steps to consider that will assist in properly achieving your goals…
First, work with your financial advisor for guidance and use them as a valuable resource for educating your child on saving and investing.
Second, research financial institutions that provide custodial IRAs. It is important to create a plan on how contributions will be invested, such as determining asset allocation and exploring desired stocks, mutual funds, and ETFs.
Finally, it is time to begin venturing on this path with your children. They will learn to become financially aware and responsible, while building on valuable lessons, like compounding and importance of saving. Jump into this process confidently with your children, so they can become financially savvy at a young age! ■
Please stay tuned for Part 2 of this Confident Kids℠ Series where I will discuss my personal experience opening my first investment account!