Is it possible to set your child up to become a millionaire? The answer, for those wondering how to make their kids rich, is yes — especially if you have an understanding of the right accounts that can lead to your child’s financial freedom.
Let’s take a look at the key accounts you need to open for a child to assure their financial future is set. Plus, you’ll find out why parents play an instrumental role in teaching children smart financial habits.
Financial Accounts Parents Need To Open for Children
Where does one start in building a child’s wealth? Private wealth advisor Dawn Dahlby recommends parents start by opening these accounts for their child(ren).
Open a Taxable Brokerage Account
A taxable brokerage account is invested with after tax dollars. Any earnings will be taxable at the appropriate capital gains rates.
By opening a taxable brokerage account, your child is able to access this money anytime. This account can also be funded with unearned income, like gifts or inheritances. Dahlby uses the example of a child who receives $1,000 a year in cash gifts from their birthday or holidays. Their parents may elect to put 25% of these cash gifts into a taxable brokerage account. This is a contribution of $250 per year.
By investing $250 per year at 8% (the average rate of return for 18 years), Dahlby said the balance of this account would equal ~$10,000.
“This approach allows the child to live for today while planning for tomorrow,” said Dahlby. “They can enjoy some of their money now, while saving for their future.”
Open a Roth IRA
A parent who decides to open a Roth IRA for their child would need to have the child be employed since the Roth IRA is contributed with earned income. This is ideal for families with a family business where parents may “employ” a child in their business or keep track of the child’s own self-employment through activities like babysitting or dog walking. Money earned may be used to fund the account and it will grow tax-free.
Unlike a taxable brokerage account, Dahlby said the child would not be able to touch the earnings in their Roth IRA. Like adults who open a Roth IRA for retirement, the only way they would be able to pull money from the account without incurring a 10% penalty would be to reach age 59 ½.
As an example, let’s say a parent is the owner of a business. They hire their child as an employee earning $6,000 a year — the maximum amount which can be contributed each year for a Roth IRA under age 50. The child could put the full $6,000 into their Roth account and max it out each year.
“Assuming the child starts employment at age 15 and invests their $6,000 annual earnings in their Roth IRA (assuming the same 8% rate of return), the child will have ~$28,000 by the time the child is 18,” said Dahlby.
There’s also the option for parents to open a custodial Roth IRA for their child which functions similarly to a Roth IRA. In a custodial Roth IRA, a parent or another legal guardian is assigned as a custodian of the account.
Open a Saving or Checking Account
Parents who would like to start off covering the financial basics may set up a child’s first savings or checking account.
Sam Palmer, head of product at J.P. Morgan Wealth Management, said as kids get older, it’s important to start teaching them about financial planning, short-term versus long-term goals, credit and investing. Parents may help open this account for children or grandparents may step in and offer assistance.
Have Early Conversations About Money Together
If a child is inheriting wealth, it’s critical for parents to have early conversations about money management, philanthropy and planning together.
Palmer recommends teaching children at a young age how to budget any money they earn. This may be money received by doing chores or from their birthday. Parents can teach their children how to set aside some money to save, to make a purchase and to help others.
The more parents have conversations with their children about money, the more it teaches children to make smart money decisions. This helps the child later in life when they need to make decisions about adjusting their spending habits and allocating what they earn to get closer to their goals.
Topics like credit, Palmer said, are important to help kids better understand.
“Many people think credit is bad, but there are instances of good credit, such as lower interest rate loans for a home or college tuition,” said Palmer.
Another topic of discussion, even if it seems early to start having it, is retirement. Palmer recommends parents encourage their high school-age children to set aside a small amount of their summer job money for a faraway goal within five to 10 years. For example, a dream vacation. This can make retirement become less of a difficult concept for a child to begin grasping since they are putting money away to reach this dream lifestyle.
“Parents play a significant role teaching children about money and instilling good financial habits early on,” said Palmer “Just like some help their kids get better at baseball, parents can also help their kids be better at managing their finances, which will become crucial in their lives.”
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