How to raise financially successful children

The other day, I read a proposal about the government (taxpayers) giving newborn babies anywhere from $20,000 to $50,000 to help fund their future.  I am not going to comment on the politics of this proposal, but it did get me thinking about how to set your kids up for financial success.

Give your kids a good home

If your kids grow up in a safe, stable, supportive home, they are more likely to be caring, emotionally stable and productive members of society.  Don’t forget this critical foundation.

Help your kids avoid poverty

According to Professor Bill Galston, a senior fellow at the Brookings Institute, a child born in the United States need only do three things to avoid living in poverty:

  1. Graduate from high school
  2. Marry before having a child
  3. Have that child after age 20

These things seem simple and obvious, but they’re very important.  If your kid drops out of high school and has a kid, they’re going to have an uphill battle.  Do them a favor and help them get the big things right.

Teach your kids principles for success

Avoiding poverty is a great start, but it will take more than that to create future success. You need to teach them discipline, hard work, contribution, and saving.  There are a number of great books out there to give you ideas, such as Smart Money Smart Kids from the Dave Ramsey empire.

Help your kids set up a Roth IRA as early as possible

Once your kid is able to get a job with earned income (around 15 or 16 years old), help them set up a Roth IRA.  They can contribute 100% (no more) of their earned income into a Roth IRA, up to $5500 (as of 2018).

Target and other retailers will be raising their minimum wages to $15 per hour by 2020.  An industrious high school student may be able to make $7200 in a typical summer ($15/hr x 40 hrs/week x 12 weeks).  That is more than enough to completely fill up a Roth IRA.

Of course, to encourage your kid to invest, you could actually give them a dollar for every dollar they put into their Roth IRA, so they get a fully funded Roth IRA AND they still have all the money they earned.  Remember, you are allowed to gift each kid $15,000 per year(per parent, up from $14,000 in 2017) without having to deal with gift taxes.

Encourage your kids to save and invest

To help your kid get into the habit of saving, after filling up their Roth with the parent match, I would recommend that they use 50% of their earned income for spending, and 50% for saving.  For example, they could contribute to a simple savings account to help fund their living expenses once they leave home, or they could contribute to a 529 plan (below) to help fund college expenses.  They should get into the habit of living on half early on.

Help your kids get an education without debt

Student loan debt is out of control.  In 2016, for undergraduate students, average student loan debt surpassed $35,000.  For graduate students in medicine, law, and dentistry, the average is closer to $200,000.  If you can give your kids get an education without debt, that will help them tremendously (as long as they appreciate it).

Consider contributing to a 529 account

One option to help your kids get an education without debt is to set up a 529 account.  This is a tax-advantaged investment account specifically for higher education expenses.  You can contribute $15,000 per year per parent in 2018 (up from $14,000 in 2017), so this would be $30,000 per year if married.  You can also front load these accounts with 5 years of contributions ($75,000 if single, $150,000 if married).  The money placed in a 529 account is not deductible on your federal income taxes, but may be deductible on your state taxes.  Moreover, it grows tax free and can be withdrawn tax-free when used for education expenses.

If your state offers a 529 plan, then you should start there for the possible state tax deduction benefit.  If your state does not offer a state plan, then just open a Utah 529 account.

It is somewhat challenging to determine how much to contribute to a 529 account.  First of all, there is no guarantee that your child will want to go to college.  It is also difficult to predict whether they will be content with an undergraduate degree or will want to pursue a graduate degree.  Moreover, educational costs are a moving target.  If you don’t use the money in a 529 for education expenses, and instead withdraw it, you will owe taxes on the earnings, and be subject to an additional 10% penalty.

Therefore, if you’re not sure if your children will want to go to college, or you feel uncomfortable with the withdrawal penalty, you can hold off on a 529 account, and use other methods to avoid educational debt.  For example, your kid could apply for scholarships and work a part time job, and you could cash-flow a portion with your own income or savings.

Help your kids develop a marketable skill

Not every kid needs to go to college.  And just because one college is more expensive does not mean that it is better.  You need to be practical when deciding what type of education to get, and how to pay for it. Your kid probably won’t have this wisdom early on, so you can help them.

For example, you could introduce the topic of trade programs, such as dental hygiene, radiology technician, or even an online programming bootcamp.  If they are intent on earning a Bachelor’s degree, you could introduce programs that deliver a marketable skill such as accounting, nursing, computer science, and engineering.  You could also discuss graduate programs, such as law and medicine, but it is important for them to recognize that these take much more time, cost much more money, and may not yield a worthwhile return on investment.

If that’s not enough

For whatever reason, if you want to give your kids a life of leisure (I don’t recommend this), you can place $30,000 per year (if married) into a custodial brokerage account for them.  If you do this for 18 years, there will be over $800,000 in there when they turn 18 (assuming a 5% after inflation rate of return).  This will be more than enough to fund a house and any educational expenses. Of course, when they turn 18, the money is theirs, and they can blow it on drugs and fast cars if they want.  So I generally don’t recommend this strategy.  You should give them the tools to make it on their own, but the rest is up to them.

“Live Free MD” is a sports medicine physician who blogs at his self-titled site, Live Free MD.

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