We got expert advice on how to pass cash down while taking advantage of tax rules.
As any parent will tell you, having a child means sacrificing a lot — your time, your freedom, sometimes your sanity. But another thing moms and dads are constantly parting with on behalf of their kids is money.
Lots of that cash goes toward the needs of right now. Whether it’s diapers or daycare, summer camp or school supplies, there’s always some expense taking immediate precedence within your budget. But then there’s the future: saving for vacations or college, or making sure your family is taken care of when you’re gone.
Though those long-term concerns might feel far away, thinking about them now is essential. One of the most powerful financial tools is time — the longer money has to gain interest and draw returns on investments, the more substantial its growth will be — so it’s to your benefit to think ahead about your savings strategies for money you plan to use years down the line.
To help make sense of this, we’re taking a look at the different savings goals parents might have and how to best tackle them. With the help of this expert advice from financial pros, you’ll be feeling better about the future in no time.
First, ask yourself: Can I actually afford to save money for my kids?
Of course you want to do it. Everyone would love to send their child off to college with a huge education fund or give them a down payment for their first home.
But the reality is that the best way to help your kids is to help yourself. Matt Becker, a financial planner and the founder of Mom and Dad Money, likes to use the classic airplane analogy: “They tell you to make sure to secure your own oxygen mask before you secure your child’s, right?”
Even if taking care of your kids’ needs today means you don’t have money leftover to set aside for their future, you’ll be saving them lots of headache (and heartache) later in life if your own needs are completely taken care of. Once parents reach retirement and their highest-earning years are behind them, the money they’ve saved for themselves will have to last the rest of their lives. If those savings are too small because they spent a big chunk of it on their child’s college education, it’s not helpful for anyone, no matter how noble the intention.
Sallie Krawcheck, the CEO of Ellevest, a financial wellness company for women, acknowledges that watching your retirement fund grow while your child may have to borrow money for school goes against a parent’s natural instinct. “But you know what also goes against our natural instinct?” she adds. “Running out of money at the end.”
“I hate to say this, it hurts my heart, but you can get a loan for college. You can get a scholarship. There’s no scholarship for retirement,” Krawcheck said. “I don’t think any woman wants her kids to have to take care of her. No one wants to be in a home that you don’t want to be in.”
Ellevest uses the “50/30/20 rule” as a guide for directing your income, Krawcheck explained: From your take-home pay, 50 percent goes to day-to-day expenses, 30 percent goes to fun things like vacations and nights out, and 20 percent goes to “future you,” for retirement.
“You can look at both that 20 percent and 30 percent and say, ‘Do I have room there for saving for my kids?’” she said.
But if you can do it, anything helps. Whether you save $10, $100, or $1,000 a month, the tax-advantaged accounts we’ll explore below will maximize the growth potential for whatever amount of money you have.
Saving for yourself can also benefit your kids if you play it smart
In Becker’s work with parents on their financial wellbeing, he suggests first prioritizing any retirement or tax-advantaged accounts available to you, such as a 401k or other employer retirement plan, an IRA, or a health savings account.
“All of those things will make sure that your own financial foundation is secure, which will put you in a better position to actually be able to sustainably help your children, and a lot of those accounts are more flexible than you might think and could be accessed if needed for college costs or other things that your children may need,” Becker said.
The most flexible of these kinds of accounts is the Roth IRA. There’s no tax deduction for contributing money to the account now, but it grows completely tax-free, and you won’t have to pay taxes when you withdraw it. You have full, penalty-free access to the money at age 59-and-a-half, making it a great way to save for retirement, but there are ways to use it earlier if you must.
“With a Roth IRA, you can always withdraw up to the amount that you’ve contributed at any time and for any reason, without taxes and penalties,” Becker said. That doesn’t include the money you earn on the account’s investments, but the cash you put into it yourself “is available to you all the time, so you can use that for anything you might need.”
If you decide that your retirement is sufficiently funded through other sources, you could use Roth IRA money — including the earnings — for college without incurring penalties for early withdrawal.
“On the earnings, there are more restrictions, but when it comes specifically to qualified higher education expenses, you can withdraw the earnings as well and avoid the 10 percent penalty that normally applies to those distributions. You will still be taxed on those earnings [if you withdraw early], but you will not pay the 10 percent penalty,” Becker said.
The point here is that tax-advantaged accounts like a Roth IRA are incredible tools for saving money for later in your own life, but because there are ways to access that cash if you absolutely need to, it’s a good place to put money without committing to use it specifically for education.
But if you are in a position to dedicate money to your child’s college, the best tool is a 529 savings plan
With a 529 plan, you contribute after-tax money, which then grows tax-free and is not taxed upon being withdrawn, but it must be used for higher educational expenses. Many states also offer perks specifically for their residents — some may allow the funds to be used for K-12 costs, and others may offer income tax deductions on your contributions. It’s important to look at your own state’s offerings to see what’s available.
A 529 plan is set up so that parents retain control over contributions, withdrawals, and how the money is invested, and they list their child as a beneficiary to the account, meaning the money must be used for their benefit.
And speaking of beneficiaries, that’s another perk to the 529 account: You can change it to any eligible family member.
“So let’s say you open the account for your first child, but you don’t need all of the money for your first child. You can just change the beneficiary to be your second child or your third child and use it for them,” Becker said. “You can also change it to yourself and use it if you want to go back to school. You can use it for nieces or nephews or grandchildren. So there is flexibility. You’re not locked into using it for the child that you originally opened it for.”
Depressing, but necessary: Planning for your death
No one wants to think about the day they leave Earth, but it’s a reality — and one you’ll want to be mindful of to ensure your family is taken care of when you’re gone. Life insurance is the perfect place to start.
“The whole point of life insurance is to protect the people who are financially dependent on you, and to make sure that if you’re no longer able to provide for them, they still have the financial resources they need to have food and shelter and health care,” Becker said.
Many employers offer a life insurance policy at little or no cost to the employee, so it’s an incredibly valuable benefit that’s easy to take advantage of. You can also add supplemental coverage on your own, which may cost more than what your job provides, but it can be worthwhile for the extra peace of mind.
The most useful part of having your own life insurance is just that — it belongs to you. “Your employer can’t take it away. If you change jobs, it’s still yours, whether or not your new employer offers life insurance. It just makes sure there’s always coverage, no matter what,” Becker said.
On the most fundamental level, there are no restrictions on how your loved ones use your life insurance payout in the event of a tragedy. The money will go to your beneficiary, and it’s up to them what to do next — unless your personal estate plan makes things more specific.
For example, if you have young children, you might appoint a financial guardian who will make decisions about money for your kids until they’re old enough to do it themselves. You might also add stipulations about when the money is released and how it’s used, such as specifying your child receives the money at 21 instead of 18, for example, or that you want a certain chunk of the payout to be set aside for college expenses.
What about saving for a wedding or a down payment for a home?
These goals should generally be the last priority for parents. It’s advisable to save for them only after your own retirement is in good shape and you’re otherwise secure.
And, unfortunately, you won’t get the same perks for these kinds of expenses that you would in some of the other accounts we’ve discussed. “Saving for something like a wedding, there’s no tax deferral,” Krawcheck said. “Nobody’s like, ‘The government needs to help you have the best wedding you can.’”
But if you are in the position to help your child with these things, the best way to do it is through a standard brokerage account that allows you to invest in a combination of stocks and bonds. And it’s important to note that though this places your money into the market, it may not be as risky as it sounds.
“Sometimes people think that investing means all of your money is in the stock market and it’s 100 percent at risk, and that’s not the case,” Becker said. “You can ratchet up or down the risk level depending on your comfort level and your timeline.”
But be aware of gift tax. Current laws state that you can give a monetary gift — to anyone, not just your child — without any tax implications as long as it’s less than $15,000 a year or $11.7 million over your lifetime. Anything above that will require filing with the IRS, but those are per-person limits, so your partner can also gift the exact same amount before the treasury gets involved.