Hugh F. Wynn
Four Financial Gifts for Your Kids That Keep on Giving
Ahhhhh...the happy holidays are here once again! Now that it's the gifting season, consider giving your kids or grandkids - or a kid you just like - the gift of financial knowledge, accompanied, if affordable, by a few bucks! It's unique, valuable, and quite literally, the gift that keeps on giving. NOTE: Since I’m not a credentialed financial advisor, the answers (observations) I give are strictly my opinion.
Let the Grinch Speak, First
In their pursuit of a higher education, 45 million folks…parents, grandparents and their progeny…owe almost $1.75 trillion (yes, that’s “illion" with a "tr”) in student loan debt. To put that number in perspective, it’s close to $850 billion more than the total credit card debt in this country – and oh, how we love our credit cards.
Sixty-nine percent of college students in the Class of 2019 took out student loans to fund their educational pursits. On top of that debt, 14% of their parents helped by doing the same. In short, young people in this country are drowning in debt at an early age, which complicates their future acquisition of new homes to accommodate new families.
IMHO, student loan choices are yours and the debt is yours, so I recommend considering these personal choices before applying for a student loan:
Do I want to go to college or pursue another line of post-high school training?
Do I want to attend an in-state school or go out of state?
Do I want to attend a public or private university?
Do I want to live on campus, off campus or at home?
Can I work part-time to fund college costs or do I borrow the max?
What field of study am I interested in, and will it result in a post-grad job that helps me pay off my loan(s)?
“It came without ribbons, it came without tags. It came without packages, boxes, or bags.” — The Grinch
So, how can we “older” folks help our youngsters fund their college dreams? A financial gift accompanied by the wisdom of experience might make a difference. Young folks find it very difficult to form retirement savings habits.
Statistics show that among those saving for retirement, only about 50% start in their 30s. These same folks, when asked, admit they should have started in their teens and most certainly in their 20s. Had they done so, what an advantage they would have gained over the late bloomers who started much later in life. And yes, this advantage is enormously enhanced by the The Amazing Power of Compounding.
Gift Idea #1: Roth IRA
Both parents and grandparents have well-known tools available to help the kids and grandkids. For older kids, Roth IRAs come to mind. But contributions to Roth IRAs must be “earned income” dollars. However, those dollars don’t necessarily have to be the recipient’s income. As long as the recipient has sufficient earned income to justify the contribution, a parent or grandparent can gift the contribution to the youngster who can then contribute the money to the Roth IRA. In other words, an individual cannot make contributions directly to another person's IRA because each IRA is linked to one person's Social Security number; thus, only that person can contribute to that account.
Gift Idea #2: 529 Plan
The ever-popular 529 plan, usually state sponsored, is a gift that an elder can give a youngster for education savings. Almost half a trillion dollars of assets rest in 529 plans. The money must be spent for qualified higher-education expenses (tuition, room and board, books, fees, supplies, equipment, computer hardware and software, internet access, etc.), but can also be used for K–12 tuition of up to $10,000 per student per year at a public, private, or religious school.
A big advantage of the 529 plan is its tax benefits. Most states allow donors to deduct 529 plan contributions on state returns, up to a given state's limit. Plan earnings are deferred from federal and usually state taxes, and the donor won't be taxed on withdrawals for qualified education expenses. What an enticing tool for helping kids or grandkids avoid those onerous aforementioned student loan debts!
By the way, as the account owner, a parent or grandparent has control of when and how the money is disbursed, even after the recipient reaches majority age.
Gift Idea #3: IRA Set-Aside
In the instance where a youngster is unlikely to produce earned income that enables the creation of an IRA, a parent or grandparent might set aside in his or her will, or addendum thereto, certain estate holdings (e.g., 15% of a named mutual fund “X”) specifying when and how the recipient will gain access to the changing value of such set-asides. This allows the donor to retain control of fund investments until certain specified dates of disbursement (including date of death) for whatever purpose.
Because ownership remains with the donor until distribution, income produced by the assigned percentage of a named asset will attach to and become part of the named asset for reinvestment purposes. And yes, taxes on such earnings will be the donor’s responsibility. This tool creates a future obligation to the recipient but allows total control of such obligations by the donor until the point of disbursement. Such an investment set-aside can become a learning experience for the recipient on the vagaries of the market should the donor choose to allow the future recipient frequent access to the market performance of the asset(s) involved.
Gift Idea #4: Grammy's Pearls (of Knowledge)
The greatest gift that can be offered children or grandchildren is financial knowledge…and the time spent convincing them to embrace that knowledge and formalize it into a plan of action. I’ve often been asked to suggest specific plans of action such as what financial assets to buy…how much…and when. I’m hesitant to provide such specificity. Why? Because there are as many such plans as there are financial advisors…Wazoos, I call ‘em. In my opinion it makes more sense to discuss a few simple and practical principles of wise investing and instill in young minds the importance of patience, diversification and quality (yep, my PDQ Principles).
I like to start with the most basic principle of all: Instead of spending every penny earned, encourage your kids to start saving a meaningful percentage of that income…and then, start investing. Most young folks don’t need all of that stuff they think they absolutely must have. I don’t need to make a list. They know what that "stuff” is. The lesson here is, if a young person doesn’t save, he or she, by definition, can’t invest. If they can’t invest, they’ll likely spend most of their adult years struggling to financially survive.
Next, it goes without saying that young folks will need a basic understanding of the fundamentals of personal finance. Unfortunately, our secondary schools don’t provide much help in this effort. That’s where parents and grandparents come in. Investing without some basic knowledge is akin to learning how to drive without the benefit of an automobile. In short, convey knowledge along with monetary gifts.
The best way youngsters and young adults participate in the aforementioned learning process is to read about and pay attention to what’s going on around them. Financial markets have histories. It comes in the form of news every day. Certainly new investors are often confused by everchanging market conditions and the economic and political turmoil that causes them. But remember, there’s nothing really new in the investment world. It’s true that history doesn’t necessarily repeat itself, but the mob tends to react to similar market conditions in similar ways – a good reason not to join their mad dash to the exit, but a good reason to let their predictable behavior help you make money. Recommended Reading: “If You Can,” by William Bernstein (a 48-page booklet written expressly for young and new investors).
A Cautionary Caveat
A word of caution: Investors, particularly young investors, are often their own worst enemy. Practically speaking, humans don’t comport well with risk over the long term – particularly we impatient Americans. Rather, most of us are geared to think short term. Which is exactly why I emphasize patience as one of my PDQ principles of investment.
It’s so important to think about financial risk over the long haul…over the several decades of our working lives. Simply put, if an investor has a presence, large or small, in the financial markets, there will be those inevitable moments when he or she stands to lose a worrisome percentage of the portfolio’s value, but these are almost always short-term events! During these inevitable “market corrections,” the real risk an investor must deal with is his or her own failure to maintain strict long-term discipline in saving and investing. Practice patience, my friend. It’s a paper loss until you sell. Do not join the thundering herd. A big cliff often lies ahead.
It’s important that young investors recognize what I call the Wazoos that roam the financial landscape. They come in many forms, and admittedly, some are very talented. But others come in the guise of Uncle Jack, a well-meaning friend, an old college buddy, a cousin, or a colleague at the office.
In whatever form, keep in mind that many professed financial professionals really aren’t…that their true primary interest is self interest. Pop or Grandpop might not be professionals, but they’re probably not trying to personally profit from your investments either, particularly if their advice involves a monetary gift.
Monetary gifts to kids or grandkids are indeed “gifts that keeps on giving.” And if the kids luck out, that monetary gift might come the wisdom and good advice of knowledgeable parents and grandparents.
By the way, to those older generations who have the time and resources to help their children or grandchildren develop meaningful savings and investment plans early on, it’s probably doubtful that you will see the results of this good advice and generosity. But take great comfort in knowing that you’ve helped pave the way for future generations’ successful financial lives and retirement.