(
10 Steps copied from the Magazine)
William Baldwin,
06.08.11, 06:00 PM EDT
Forbes Magazine dated June 27, 2011
Here's how to ensure that your family's next generation is an affluent one.
We're spending our children's money. So goes the refrain from people appalled at the government's deficits. As long as entitlement spending and tax collections continue on their present course, it's an undeniable truth.
Instead of wringing your hands, do something about it. Make your children so prosperous that they can withstand the Medicare cutbacks and tax increases that lie ahead. Here are ten tactics for boosting the net worth of your offspring.
Step 1 - Don't Over-educate
That master's degree your son or daughter wants to get may be a bad investment. This heretical thought comes from
Laurence Kotlikoff, a Boston University economist who studies earning and consumption patterns. An advanced degree confers a higher salary, but it comes at a high cost, too. It includes tuition, often borrowed, plus a year or more of lost earnings.
Kotlikoff can show you how a hardworking M.D. may wind up with only slightly more spendable income over a lifetime than a plumber. He compares a doctor practicing in Ohio with a plumber from the same state.
Using statewide averages, he pegs the doctor's peak pay at $185,900 and the plumber's at $71,700. His hypothetical doctor, however, has a much shorter career; she doesn't finish her residency until 11 years out of high school. She shells out a lot of money on tuition,
student loan interest and income taxes. The plumber winds up with $33,200 a year of spending money (in inflation-adjusted dollars) over his adult life. The doc can spend only a little more: $33,700 a year.
Pursue academics if you love hitting the books,
Kotlikoff says. Don't do it for the money.
High Payoff Majors
Median Earnings
Petroleum Engineering: $120,000
Pharmacy: $105,000
Math/Computers: $98,000
Low Payoff Majors
Theology: $38,000
Early Childhood Education: $36,000
Psychology: $29,000
Step 2 - Find a Cheap B.A.
In a similar vein is the fallacy that degrees from prestigious universities are particularly valuable. The reality, argues
Kotlikoff, is that their grads do well in life because of talent and ambition, not because of what they pick up in the classroom or even the doors that open to those who hold a fancy sheepskin. If your youngster gets into an elite school offering no
financial aid and a lesser one with a $10,000 merit scholarship, make sure he or she considers the second option carefully.
Another strategy would be for your kid to do a year or two at a
community college and then switch to the state university. Joshua Nicholas, a 24-year-old property adjuster at Travelers, spent two years taking University of Delaware courses offered at
Delaware Technical & Community College while living at home. He spent his junior and senior years at the university's main campus in Newark, where he received a B.A. Nicholas left school weighed down by $40,000 less
in debt than did a roommate who'd spent all four years at the prestigious campus.
Cheap Colleges
These are tuition-free, but you may have to cover room and board--or work.
Berea College
Cooper Union
Deep Springs College
U.S. Military Academy
Expensive Colleges
These are at the high end for tuition, room and board (2010-11).
Bard College: $54,300
Columbia University: $54,400
Sarah Lawrence College: $57,600
Wesleyan University: $54,000
Step 3 - Fund a Roth
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.
Three things make this strategy a winner: the positive effect of incentives (even those whose payday is a half-century away), the tax code's preference for retirement savings and the power of compound interest.
Your kids are allowed to contribute to
individual retirement accounts only up to the amount they earn from employment (investment income doesn't count). As long as you stay within that limit, however, the dollars can come out of your pocket.
Suppose daughter Caitlin earns $5,000 this summer waiting tables. She uses the money on
college tuition, if that's what your arrangement is, or if not then on whatever. Separately, you deposit $5,000 into her Roth IRA. That's the kind Caitlin can't deduct from her current year's tax bill but whose principal and earnings are tax-exempt when withdrawn decades in the future.
This is a smart move. Caitlin probably won't owe any federal income tax on that summer job in any case, because her standard deduction will more than cover it. Since Caitlin would get no benefit from an upfront
tax deduction, she's better off opting for total tax freedom on her withdrawals when she retires.
Be careful with this strategy if your child plans to apply for
financial aid. Aid formulas generally treat assets held in your name as only partially available to cover college costs; those held by your kid are considered fully available, even if held in an IRA.
To avoid having Caitlin's Roth money confiscated by the college bursar, put off funding it until April of her junior year--after she's handed in her final-year financial aid forms. The IRS permits contributions this late on earnings from the previous summer. Then wait another six months, until the fall of Caitlin's senior year in college, to add a contribution covering her earnings from the most recent summer.
If your bank is flustered by the idea of kiddie Roths, take your business elsewhere. Mutual fund companies are more hip to this strategy.
Number of kiddie ROTH accounts at Vanguard: 40,000
Maximum annual contribution: $5,000
Do plan carefully if your child may qualify for
college financial aid
Don't fund a child's retirement unless you have maxed out contributions to your own
Step 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.
Average cards held by college students: 4.6
Average card debt: $3,200
From a 2008 survey of college loan applications. Source: Sallie Mae
Step 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.
Expensive Plans
10-year cost on $10,000 investment
1
State: Highest Cost Option
District of Columbia: $2,498
Nebraska: $1,900
Missouri: $1,878
Kansas: $1,690
Wisconsin: $1,630
Cheap Plans
State: Lowest Cost Option
Utah: $262
Virginia: $257
Ohio: $243
Rhode Island: $77
Louisiana: $0
Step 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). 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.
Step 7 - 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 (
JPM -
news -
people ), you're sure to get a call in April of freshman year pleading, "I'm out of money!"
Step 8 - 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 stock 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.
Do give away appreciated stock you want to unload.
Do watch out for
kiddie tax on recipients under 24.
Don't give away depreciated stock. Just sell it.
Step 9 - 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.
Homeownership rate for those under 35: 37.9%
Fractions of last year's buyers under 25: 6%
Step 10 - Hire Your Offspring
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.
