Turn Your Kids into Millionaires
from:
http://blogs.forbes.com/baldwin/2011/06/10/turn-your-kids-into-millionaires/?partner=yahootix
Jun. 10 2011 - 11:43 pm | 584 views
By WILLIAM BALDWIN
Are you worried about the trillions of dollars of federal debt we’re leaving to the next generation? Don’t feel guilty, do something. You can start your kids now on a path to financial independence. Here are ten recipes for doing just that.
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1 Beat College Debt
The average grad gets out of school with $20,000 of debt. That’s a crushing burden for someone getting—or just hoping to get—an entry-level job. If you can lead your kids to a cheaper university degree you give them a healthy push forward in their financial lives.
One strategy: Have your child start at a community college, then transfer to the more prestigious state university. Another: plan college spending and your own retirement saving years in advance so that you don’t get boxed in by financial aid formulas. I detail those tactics and others here.
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2 Fund a Roth IRA
Tell your kids you will match every dollar they earn working, provided that your dollars go into a retirement account they promise not to touch for 50 years.
It sounds a bit extreme, sitting a 17-year-old down to talk about his or her own retirement planning. But tax-favored retirement accounts are a powerful way to build wealth. Chipping in to a savings account now is a lot better than helping out in other ways (like offering to buy the youngster a first car).
You can put away $5,000 a year in the kid’s IRA, provided he earns at least that much in a job. Compound $10,000 at 8% and it will grow to $469,000 by the time that teenager hits retirement age.
If the money is in a so-called Roth account it will compound tax free and come out tax free.
Where are you going to get 8%? I think that’s a reasonable expectation for the long-term return on a stock index fund, such as SPDR 500-stock fund (SPY).
If the youngster can’t stand the volatility, mix in some bonds: risky bonds in the SPDR junk fund (JNK), high-grade bonds in the iShares corporate bond fund (LQD) or still more safety in Vanguard’s bond market index fund (ticker BND). But bonds will dilute your returns.
These exchange-traded funds are all suitable for self-directed brokerage IRAs. For account balances below $10,000, however, I’d recommend no-load mutual funds instead. Stick to cheap index funds.
You may encounter stumbling blocks. The bank that has a giant IRA sign in the window may go all weak in the knees when you try to explain that retirement account are indeed legal for minor children. I tell you how to get over that hurdle and others in this article.
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3 Start Them Young
Children should learn about budgets—and limits—at an early age. Instead of giving kids small allowances for movies and candy, give them larger ones and have them pay for things like clothes and transportation. This will teach them about tradeoffs and buyer’s remorse.
If instead you send a financially sheltered child off to college, says Deborah Cox, a family wealth adviser with JPMorgan Chase, you’re sure to get a call in April of freshman year pleading, “I’m out of money!
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4 Shun Card Debt
Through your words and deeds, get your children to take to heart the notion that revolving credit card balances are an addiction foisted on the middle class by an evil industry. The average running card balance is $8,000. At a 15% interest rate that balance will, over a lifetime, impoverish the borrower by $60,000 in interest charges.
Teach your kids to pay off balances in full. If that’s beyond them, consider debit cards—the kind with no overdraft feature.
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5 Shop For A 529
If you’re like most parents, you’re hounded by every planner and financial institution you’ve come in contact with to open a Section 529 college savings account. The selling point is that earnings are free of tax if you withdraw the money to pay for college.
Some 529s are a great deal, offering low overhead costs and an immediate deduction on state income taxes for deposits. Some plans are stinkers, with high fees and no tax deduction.
New York has a good deal: a deduction on a joint return for the first $10,000 a year you put in and a 0.25% annual expense ratio if you invest directly rather than via a broker. In Texas, by contrast, you get no tax deduction because the state has no income tax. Buy into the Texas 529 plan through a stockbroker and expenses could top 2.3%. That’s enough to erase any federal tax benefit on the earnings.
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6 Give Away Grandpa’s IRA
Let’s say your father just died at age 85 and left you his $100,000 IRA. If he put his affairs in order, his beneficiary designation forms named you as primary beneficiary and your two children, ages 12 and 14, as secondary beneficiaries. You can “disclaim” the money so it goes to the kids.
The passing of the money to the next generation allows the account to compound tax-deferred for many more years. The extra compounding comes into play because the required minimum distributions will be based on your kids’ expected life spans instead of your far shorter one. Your 12-year-old will have to withdraw $700 of his $50,000 in his or her first year and will owe what’s likely to be a minimal amount of tax on it.
If all goes well the youngsters will still be enjoying the inherited tax shelter when they become grandparents themselves. In the meantime, stick the required distributions into a taxable (non-IRA) account. Your kids will gain control of both the inherited IRAs and taxable accounts upon reaching majority—usually at 18 or 21 (depending on the state and the nature of the account). If you’ve adequately indoctrinated them in the value of thrift, however, they will gladly let the IRA money ride for many more years as it swells into a sizable nest egg.
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7 Give Stock
If you are in a high tax bracket, you likely own a wide assortment of stocks, bonds and funds. Some will go up and some down. Sell the losers to defray income elsewhere on your tax return. Give away the winners.
If the recipient has a low income, he or she will owe no federal taxes on the capital gain. You could, for example, give your daughter a $12,000 block of Sirius XM for which you paid $7,000. She sells it in order to buy a house. If her taxable income (including the $5,000 gain on the stock) is less than $34,500, the gain is federally exempt. If she’s married, she can have a taxable income on her joint return of up to $69,000 without losing the 0% rate.
This strategy works for children ages 24 and older. Younger ones may get hit with a kiddie tax, which throws investment income in excess of $1,900 into your tax bracket.
The 0% capital gains rate for low-bracket taxpayers is set to expire in two years but stands a decent chance of being extended.
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8 Put Your Kids In a House
The gift of a down payment that gets your kid into his or her first home can create a benefit compounding over decades. Fearful that the housing slump could drag on a few more years? It’s not worth the worry if you stretch out your horizon to 20 or 30 years.
There’s a powerful tax advantage to owning rather than renting, and it reaches well beyond the mortgage-interest deduction that is usually thought of as the prime homeowner goodie. The benefit is this: If you put capital into stocks and bonds and use the earnings to pay rent, you’ll owe tax on the earnings. If you put the same capital into a home you will get a dividend in the form of living space—and this dividend is tax free.
Cashing out is tax-favored, too: Up to $500,000 per couple of homeowner capital gain is exempt. You don’t get that with your stock portfolio.
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9 Hire Them
If you own a business, put your kids on the payroll. They have to do real work, to be sure, and you can pay them only what you’d pay other people for the same tasks. But if they can surmount these hurdles the tax benefits are large.
A child with no investment income pays 0% on the first $5,800 of earned income. So, by shifting income between generations, you can effectively lower the federal income tax on it from 35% to 0%. That savings more than covers the Social Security tax imposed on earned income. You can combine this income-shifting strategy with the Roth gambit described on page 68.
Tonia Dyas, a database programmer in Rescue, Calif., has her 13-year-old on the payroll at $325 a month as an office assistant. He’s young enough to rate an exemption from Social Security and Medicare tax for family employees.
Troy Onink, a financial planner who specializes in saving for college and retirement, takes this tactic to another level. He says that college students with valuable skills can sometimes make enough money in a family-owned company to cover more than half their college costs.
At that point they become eligible for a valuable tuition tax credit that their high-bracket parents cannot claim. The high earned income also enables them to escape the kiddie tax on appreciated securities. If you can pull it off, the Onink strategy gives you a five-way win: a shift of earned income to a lower bracket, a fat standard deduction, a Roth, a 0% rate on your stock gains and a tuition tax credit.
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10 Educate the Grandparents
If your parents are retired and have significant savings, there may be a way to improve your family’s well being as assets are handed down to the later generations. Perhaps the retirees are living frugally out of concern that they might have to cover their living costs well into their 90s. In all likelihood, though, they won’t be living to age 99. They will be leaving some money to children or grandchildren.
The seniors could lower their risk of outliving assets by buying what’s called a longevity policy. It’s a monthly annuity that kicks in only when and if the buyer reaches an advanced age (like 85). That kind of annuity is very cheap if the buyer is much younger (like 70).
This kind of insurance might enable the older generation to loosen the purse strings now. They could help out financially when your kids need help the most—as they struggle with college loans, buy their first house or begin to contribute to a 401(k).
