How to Set Your Kids Up for Financial Success

In the late 1900s, saving for your child was fairly simple. Often, family members gave kids government savings bonds, and parents or guardians may have opened a traditional savings account in their child’s name. Today, parents have significantly more options; what was once a simple task can now be confusing and overwhelming.

Don’t let the complexity of saving for your child discourage you from acting. One of the most meaningful and beneficial things you can do is to set your child up for financial success. Preparing for their future can help them launch their adult lives when they’re ready.

Not sure where to start? Here are four ways you can set your child up for financial success:

1. Set Up a UTMA Custodian Account

A great way to better your children’s financial acumen is to establish a Uniform Transfer to Minors Act (UTMA) custodian account for them.

UTMAs allow you to create an investment account (typically with a brokerage firm) in which you name your child as the beneficiary while you, the parent, are the custodian. Parents can contribute assets such as cash, stock, bonds, exchange-traded funds (ETFs), mutual funds, life insurance policies, real estate, and intellectual property to the account. Contributions are free from the gift tax as long as they qualify for the annual exclusion (up to $17,000 in 2023).

The UTMA custodian account acts as a typical investment account; however, legal ownership of the account and all of its assets will transfer to the child at the age of majority (typically by age 18 or 21, depending on your state).

A UTMA account can encourage your child to take a leading role in their financial success from an early age. Consider letting them take control of the entire investment cycle, such as making contributions to the account (perhaps with an allowance you pay them), choosing investments (under your supervision), and gathering and analyzing their documents for the tax preparation or planning process. Allowing them to play a primary role in their investment decisions will foster strong financial habits.

A major disadvantage of a UTMA account is they are technically owned by the child. Therefore, the account will be considered a source of income to determine the child’s financial needs when applying for financial aid for college. Also, trust must be a non-factor with your child since they will have full autonomy once they reach the age of majority.

2. Fund a 529 Savings Plan

For many Americans, graduating from college remains the predominant way to kick-start a career with promising earning potential. A popular way to save for your children’s college expenses is to establish and fund a 529 savings plan.

529 plans are offered at the state level and allow account owners to invest in assets such as stocks and bonds, instead of being limited to saving account returns. The earnings within a 529 account grow tax-free as long as the beneficiary uses the funds for qualified education expenses, such as tuition and fees, supplies, and textbooks.

Beyond covering college expenses, 529 plans offer other benefits to both the account owner (parent) and beneficiary (child). For instance, the account owner can change the beneficiary should the initial beneficiary decide not to attend school. Beneficiaries can also use 529 plans to pay off up to $10,000 in student loans. Lastly, starting in 2024, beneficiaries can roll up to $35,000 of 529 plan funds into a Roth IRA.

Lawmakers have included some important rules and limitations governing such rollovers. Even so, this is a major benefit for parents who are concerned about not being able to use all of the money on college expenses.

3. Establish an Irrevocable Life Insurance Trust (ILIT)

If you have substantial income and assets, creating an ILIT may greatly benefit both you and your children in the case of an unexpected death of a parent.

With an ILIT, you, as the grantor of the trust, can purchase a life insurance policy inside of the trust. Since the trust is irrevocable, the proceeds from the life insurance payout upon death will go to the trust instead of your estate, thus escaping its inclusion in your gross estate.

For larger estates, this may lead to substantial estate tax savings and increased privacy for the family.

How does it work? Upon an unexpected death of a parent (the insured on the policy), the life insurance proceeds will be disbursed to the trust and fall under the management of the trustee, who will have a fiduciary duty to pay out the proceeds to the children and follow the rules of the trust document. This feature is vital if you’re concerned your children may squander their inheritance.

While a standard life insurance policy with a death benefit will provide the same benefit as depicted above, the irrevocable trust feature is helpful for families who want to lower estate taxes on the deceased’s estate or for families who would like a trustee to exercise fiscal responsibility over the life insurance proceeds after the parent’s death.

4. Establish “Funds” and Match Their Contributions

It can be extremely difficult for children to develop strong financial habits with outside distractions and myriad opportunities for them to spend. Achieving financial literacy should be a fun and interactive process for your children. When children have an incentive to save, they’ll be more likely to do so.

One great way to incentivize saving is to establish different funds for your children and assign a matching contribution to each of them.

Let’s say your child has an interest in becoming a property owner, purchasing a new vehicle, and starting a business. Consider creating a “fund” for each of these accounts; you may hold the funds in investment vehicles such as savings, brokerage, or retirement accounts (i.e., an IRA). Once the accounts are created, assign a matching contribution to each account.

For example, you may open a high-yield savings account for your child’s property ownership “fund” where you match 25% of their annual contributions as long as their contributions meet a certain threshold (i.e., your child is required to contribute at least $1,000 to the fund to receive the match).

The key here is to make your child an integral part of the savings process. Review your account statements together, perform analytical reviews, and allow your child to visualize their income growth so that they stay invested in the process.

Still Need Help Preparing for Your Child’s Financial Future?

Having a certified financial planner with the knowledge and expertise to help you with your child’s financial future can make all the difference. Please schedule a consultation with us today to get started.

Malik S. Lee, CFP®, CAP®, APMA®
Malik Lee is the Managing Principal of Felton & Peel Wealth Management. A CERTIFIED FINANCIAL PLANNER™ with more than 15 years of financial services experience, he is a Guest Lecturer at Morehouse College, serves on the CFP Board Council of Examinations, and is a Board Member for the FPA of GA.
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