Help Your Kids -- While You're Still HereApril 1, 2007
There's no need to die first.
Planning to pass along money to your children? Sure, you could wait until your death. But there's a good argument for handing over some of your wealth a little earlier.
Here is a look at the benefits and pitfalls of enriching your kids while you are still alive -- and some thoughts on how to do it, should you decide to go ahead.
Making the Case
Yes, there are risks involved. If you give money to your kids when they're minors, it could hurt their chances of college financial aid. Even if they are in their 20s, they may not be mature enough to handle the money responsibly.
There is also the risk that half the money you give to your children could eventually be lost in a divorce. And, of course, there's the biggest risk of all: That you will give money to your children -- and then discover you need it for your own retirement.
Still, I believe the potential benefits more than outweigh the risks. What benefits? For starters, it could be a financial bonanza.
If you invest money in your children's names and then it is left to compound, it should be a huge sum by the time they retire. True, you could have the money compound in your own name and then bequeath it.
But the odds are, you will save on taxes by putting the money in your children's names. They may be in a lower tax bracket or you might be able to stash money in tax-favored accounts.
Getting money out of your name could also trim the federal or state estate-tax bill that might be due upon your death. Suppose you and your spouse have three children. In 2007, you could give them each $12,000 without worrying about the gift tax, and your spouse could do the same, thus shrinking your estate by $72,000.
Maybe more important, if you can get money into your children's names and they start to see it grow, they will learn firsthand the value of saving and investing. The money will provide them with a sense of financial security -- and helping them will likely give you a lot of pleasure.
Starting Them Young
How should you go about handing over your wealth? As I see it, the goal is to help your kids pay for major expenses, such as a home, retirement or the grandchildren's education. And by specifying how you would like the money used, you are also passing along your values.
My advice: Don't just hand over a fat check. Instead, tell your kids why you're giving them the money -- and then emphasize that by stashing the cash in a separate account. As an added bonus, if the money you give stays in its own separate account in each child's name, there's a good chance they will hang on to it in a divorce.
Which special accounts should you use? If you want to give your toddlers a head start on saving for retirement, consider opening a low-cost variable annuity. Variable annuities are typically a bum investment.
But your kids should fare just fine with the low-expense offerings from Fidelity Investments and Vanguard Group. A variable annuity will give them decades of tax-deferred growth and the tax penalty on early withdrawals should discourage them from tapping the account before age 59½.
Better still, if you have teenagers with earned income, help them fund Roth individual retirement accounts. While a variable annuity provides tax-deferred investment growth, a Roth goes one better, offering tax-free growth.
Meanwhile, if your goal is to assist your youngsters in one day purchasing a house, consider buying them mutual funds in a custodial account set up under your state's uniform transfers to minors act. That way, you will get a modest tax break. Children under age 18 can have investment income of $850 each year and pay no taxes. The next $850 is taxed at the child's rate, which will mean a modest tax bill.
Don't, however, put money in your kids' names if you expect them to qualify for college financial aid. Assets held in a child's name can count heavily against the student in the financial-aid formulas.
Got grandchildren? You might help with college costs by opening 529 college-savings plans. A 529 plan grows tax-free when used for college costs. Moreover, if you -- as the grandparent -- control the accounts, the money involved should do little or no damage to your grandchildren's aid eligibility.
Subsidizing Savings
Once your children are out of college, encourage them to stash money in their employer's 401(k) plan. You might, for instance, offer to subsidize their retirement-account contributions, giving them maybe 50 cents for every $1 they contribute.
Let's say you do that for the first 10 years that your adult children are in the work force, so they sock away $3,000 a year from age 22 to age 32. Even if they never added another penny, the money would be worth almost $164,000 at age 65. This $164,000, which is figured in today's dollars, assumes the money clocks 8% a year, while inflation runs at 3%.
If your kids are investing outside a 401(k) plan, getting them started can mean a hefty outlay, because many mutual funds now demand a $2,500 or $3,000 initial investment. My suggestion: Check out AARP Funds in Tewksbury, Mass., and T. Rowe Price Group in Baltimore.
The regular minimum at T. Rowe Price is $2,500, but the firm will waive that if you commit to investing $50 a month through an automatic investment plan. First-time investors might buy one of the T. Rowe Price Retirement funds.
These funds combine a broad array of market sectors in a single mutual fund, thus offering one-stop investment shopping. Each fund is geared toward a particular retirement date. For instance, if your daughter is age 25, she might purchase T. Rowe Price Retirement 2045.
Meanwhile, AARP's lineup includes just five funds. These five are open to all investors, not just AARP members, and the regular minimum is a mere $100. If your kids are aiming to start saving for retirement, you might suggest AARP Aggressive Fund.
The fund owns a mix of 60% U.S. stocks, 15% foreign stocks and 25% bonds. Each of the three segments is invested in a market-tracking index portfolio, allowing the fund to charge a svelte 0.5% in annual expenses.