Investing For Your Young Children: How To Balance Proactive Saving & Financial Education

Most parents understand the importance of teaching financial education and literacy to their children. But, few know how to go about doing it. When push comes to shove, there tend to be two prevailing questions.

  1. How do I set my children up for financial success without coddling or spoiling them too much?
  2. How do I equip them with the financial knowledge and principles necessary to function independently in the future?

It’s a fantastic gift to have the financial ability to invest for your child’s future. By establishing a proactive savings plan for your children and taking the time to educate them along the way, you’ll set yourself and them up for success. 

Today, we’ll take a closer look at how you can strategically invest for your children. 

Planning For College—The Big One

When it comes to saving for a college education, there are a few proven strategies and investment vehicles to consider.

  1. 529 Plans: The most common college savings account. These accounts allow parents to make after-tax contributions that grow tax-free, and distributions remain tax-free for qualified education expenses. It’s like a mega Roth IRA for college expenses.
  2. Roth IRAs: While typically earmarked for retirement, you can also use Roth IRAs for college education. You’re able to withdraw your contributions (not earnings) from the account at any time, penalty-free. Keep in mind that you want to be strategic about using Roth IRA funds for college. It may not be best to rely on that one source as it offers lucrative retirement benefits. Plus, distributions count on the FAFSA, which could have a domino effect on aid eligibility. Like 529 plans, you fund a Roth IRA with after-tax contributions that grow tax-free and qualified distributions remain tax-free. 
  3. Taxable Brokerage Accounts: The most flexible college investing strategy. Brokerage accounts lack the tax efficiency of 529 plans and Roth IRAs, but where they lack in tax savings, they make up for with flexibility. You can tap your brokerage account to fund any goal, and they are excellent vehicles to supplement a college savings plan.

Now that you have a sense of where to invest, what strategies can help you invest better?

Use Your Financial Education to Create A Plan

Investing intentionally will increase the success of your plan. Take the time to make sure your child understands the key variables of the plan. Discuss the cost, current savings rates, and the time remaining to compound investments and grow savings. 

Cost

First, estimate the cost of college. As you are probably aware, the cost of college has been skyrocketing for decades, and it’s nearly impossible to project the cost of college 5, 10, or 15 years from now. Fortunately, you don’t need exact numbers to formulate a bulletproof savings plan.

Online calculators can help you estimate the future cost of college. Vanguard, Calculator.net, and Savingforcollege.com provide some easy-to-use calculators to get you started.

A little tip: when in doubt, overestimate. Using the three types of accounts mentioned above, you can create a flexible strategy that accommodates for uncertainty. For example, you could split savings between 529 plans and brokerage accounts. If you overestimated the cost, you could use the brokerage account for any other goal.

Savings Rate

Once you have a loose idea of the costs, determine your monthly savings rate. The amount of money you should save every month is highly dependent on your current savings, time horizon, and assumed rate of return. Let’s review a simple example.

Assume you have $0 saved for college, and your child was born this month. You use one of the calculators above and determine the cost of college 18 years from now will be $250,000 for a 4-year education. After some research, you also determine the expected annual rate of return on your savings will be about 5%.

The Math: Based on an 18 year time horizon and 5% annual return, you would have to save $716/month to achieve a future balance of roughly $250,000.

Time and Opportunity Costs

How can you talk with your kids about all this stuff? Here are two ideas. 

  • College Cost vs. Career Opportunities: Now is an opportune time to talk to your child about the cost of college relative to career opportunities. After all, college should be considered an investment with an expected return (a rewarding career). If you plan on having your child pay for a portion of their education, this conversation becomes much more important. For this reason, you may want to have them pay for a small part of the total cost (even if you have the funds available). It’s ideal for your child to have some “skin in the game,” and planning for education costs is a wonderful teaching moment for that. 
  • Time Value of Money: One of the most critical elements of investing is time—time has a lot of value, especially where your money is concerned. This is a foundational tenet of investing. Take the time to show your children what would have happened if you waited too long to start investing in their education. The earlier you start, the easier it is to take advantage of compound returns on your investment. Using our previous example, you would have needed to contribute roughly $935/month (as opposed to $716/month) if you started savings just three years later. Seeing these numbers may encourage them to get a jump start on investing.

Investment Accounts For Kids

Speaking of investing, if your children are a bit older, it may make sense to open some accounts in their name and/or have them start saving independently. This can help improve their financial education and make the investing process feel much more tangible.

Here are a couple of ways you can introduce your kids to the world of investing. 

  1. UTMAs: An UTMA is a custodial account that anyone can contribute to (including minor children). These accounts function much like a typical investment account with two significant differences.
    • Control: The child owns the assets in these accounts. Once they reach the age of majority, they have complete control over how they use the money.
    • Taxes: Annual account earnings below $2,100 are taxed at the child’s income tax rates (which is likely far lower than your tax rates). Additionally, the money you contribute on their behalf is exempt from any gift tax (up to $16,000 per year in 2022).
  2. Roth IRAs: If your child has earned income, they can contribute to their own Roth IRA. Contributions are limited to the lesser of the amount they make in a given year and the annual contribution limit ($6,000 per year for 2022). As long as the child’s annual earnings are enough, parents can choose to “fund” contributions in the account up to the yearly limit. For example, your child earns $9,000 over the summer. He or she could contribute $3,000 of earned income to their Roth IRA, and you could match with a personal contribution of $3,000. 

Investing for your child comes with essential conversations. Each lesson helps them build their financial education.  If your child has their own investment accounts, you can start by explaining why investing is important and how it has helped mom and dad build wealth to support the family.  

Teach Them How To Save For Specific Goals

Sometimes your children will have specific goals in mind. Regardless of your personal contribution to the goal or the investment vehicle used, mapping out a savings plan with your child can be a rewarding experience.

Here’s a fun way to get started. 

  • Choose A Goal: Some common goals include a car purchase, home down payment, wedding, or business venture. 
  • Determine Time Horizon & Asset Allocation: Once you have the goal set, work with your child to determine the time horizon. When will they need the money? In general, the longer the timeline, the riskier they can be with the investment. Here are some general investment allocation guidelines.
    • 0-3 Years: Mostly cash savings and conservative investments such as short-term bonds.
    • 3-10 Years: A blend of stocks and bond investments.
    • Over 10 Years: Mostly stock investments.

With this exercise, your child will quickly learn what it means to prioritize various goals. When they realize that they only have so much to save every month, suddenly they must choose between a car today and a future home purchase. This exercise is a fantastic way to boost their financial education and introduce the importance of budgeting and growing your income over time.

Pulling Their Financial Education All Together

Formulating a financial plan for yourself can be challenging, but it’s rewarding. Saving, investing, and building wealth are life skills that your child won’t learn anywhere else. Start improving their financial education from day 1 even if you are just explaining to them why you bought the Toyota instead of the Mercedes even though you had the money. Building wealth isn’t just about saving money for your retirement in your 70s. It’s about learning to be independent while broadening your horizon with opportunities that help you take control of your life. 

At Bienvenue Wealth, we work with our clients to prioritize their financial goals and set their children up for financial success in the future. Schedule some time with our team today and learn about our unique planning process for the sandwich generation.

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