Imagine where you would be today if someone invested in you as a child. Maybe you’d have more money, a better career, and more skills.
How easy would it then be?
Whether it happened to you or not, you now have the chance to do so with your kids. So that they never have to face the same difficulties again.
When parenting, we tend to overlook money matters. It’s common to underestimate what it costs to raise children and how to invest in their future.
While most see this future as higher education, money is rarely taught in school. It’s no surprise that most students start their careers with the wrong habits, in debt.
But it doesn’t need to happen that way, because it’s never too late to invest in your children’s future.
- Why Invest in Your Children’s Future?
- Where to Invest First
- What You Must Know Before Investing in Children
- How to Prevent the Misuse of Your Funds
- Educate Children About Money Traps
- The Bottom Line
Why Invest in Your Children’s Future?
If you’re saving money for your newborn’s college, that’s money that remains unused for years. It makes more sense to invest it somewhere else, and then in your child, once you earn more.
So when should you invest in your children? As early as possible or as late as possible?
Consider the following:
- If you invest early, you can wait for longer, and thus take low-risk strategies. It’s almost guaranteed that your child will make money, which can help both their career and your retirement
- It’s not enough to parent your children until they move away. Unless you teach them the right skills and mindset, they’ll fall for the same mistakes everyone makes
- One of the best ways to invest in your children’s future is economic because money solves the majority of life’s problems
- Parenting is more expensive than parents expect. Either you start investing early, or you’ll lose your savings before they grow up
While money is good for your child’s future, financial intelligence is better. It’s showing your kids how money is made and how to invest it. So that they manage it the best way while earning more themselves, and not relying on your money.
‘Give a man a fish, and you feed him for a day; teach a man to fish, and you feed him for life’ – Lao Tzu
Consider everything you learned in the past years about personal finance. If you could unlock that knowledge 5, 10, 20 years, how different would your life be?
How do exactly invest in a child?
Traditionally, investing is defined as putting money expecting a return/profit. Which is ironic, because everything about children seems to be a liability, at least the first decade.
The goal isn’t to just throw them money, but to teach them to generate wealth by themselves.
The ordinary approach is:
- Open custodial accounts for your child and put some money in them
- Find some securities that provide consistent returns and invest there
- Let it compound while your child grows up
This works if you’re willing to wait for decades. But to build wealth faster, money isn’t the only way to support:
- If you own real estate and collect monthly payments, you can pass that asset to your grown-up children
- Maybe you have a long contact list your children can access in the future. Or you encourage them to meet more people and increase their network
- You teach them what you know about money so that they save time and money on financial mistakes
- You help to develop financial skills so that they’re good at money without relying on you
The good news is, it’s going to be easier for them than it was for you. Because there are many programs that facilitate investing in your children.
Where to Invest First
Take advantage of tax-deferred plans
Tax-deferred plans save you time to earn more interest. As a high earner, you’ll prefer to tax your dollars after they compound (401K & traditional IRAs). Or as a low-income parent, you’ll want to pay tax first and withdraw your interests tax-free later (Roth IRA).
You can open custodial accounts for both plans to start compounding money. And because your kids start so early, it may be worth paying the 10% penalty fee to withdraw before 59 years old.
Regardless of your strategy, they both have a yearly contribution limit (which is slightly higher for families). So if you want to invest the most you can:
- Invest as early as possible
- Max out your yearly contributions
Although 401Ks and IRAs target workers, similar tax plans exist for college students.
The UTMA (Uniform Gifts to Minors Act) is a savings account funded with after-tax dollars. For up to 25 years, you can add up to $15,000 ($30,000 for married couples) per year without gift-tax consequences.
Once your children reach the age of majority, they’re entitled to this account. Until then, you have full control over how to invest and spend. And while most people invest in college, UTMA custodial accounts can be used for anything.
But if you had to start with one plan, it should be the Health Savings Account, if you qualify for it. The HSA is a tax-free fund with a yearly limit of $3,600 ($7,200 for couples), which increases by $1,000 for parents over 55. Despite the low limit, the tax advantages are worth it.
If your employer offers HSAs, part of your salary may go straight to this account, with no taxes in between. Not even when withdrawing.
The penalties are harsh, however:
- Pay 6% if you invest more than the limit (your employer’s contributions count too)
- For those under 65, if you withdraw for non-qualifying medical expenses, you pay 20% plus income taxes
Gifting money to children
It can be complicated to set the financial structure for your child. It’s easier to just invest in your accounts and share those funds with them.
This way, you’re in full control of your money. All your child needs is an account where to send the monetary gift.
Ideally, you’d transfer money to your children that way. But if it were that easy, everyone would be using gifts as a payment method.
Up to $15K per year ($30K for married couples) is all fine. Cross the limit, and you’ll have to report it to the IRS. And taxes range from 18% to 40%, depending on the amount sent.
Who pays them? The giver.
And gifting too much affects your estate taxes too.
In 2021, you qualify for $11.7 million of lifetime estate tax exclusion. If your estate is worth more than this number, that extra money is taxed.
Suppose that over your lifetime, you’ve exceeded the $15K gift limit by $3 million. Your state exclusion isn’t 11.7 any more, but $6.7 million.
If you don’t want to overpay for taxes, carefully time how much you give every year.
Receive money from a will or trust account
If you have lots of money but don’t want to pay for gift tax, consider wills and trust funds. After you pay a fee, you can keep your money with tax advantages for your beneficiary.
A will is a legal statement that allows you to choose who uses your assets/money, when, and how. The sum of your assets on your death is called the estate, and as long as it’s worth under $11.6 million, you pay no taxes.
Otherwise, it’s 18% to 40% depending on the tax bracket (for trusts as well).
While the will becomes active after your death, a trust is always available if the beneficiary is above the age of majority.
In a trust, you (the trustor) trust a company (trustee) with money for your kids (beneficiaries). If your trust is revocable, you can undo the statement and recover your amount if you wish. If it’s irrevocable, you can’t, because you no longer own the assets.
The benefit is, you pay no income tax.
Whether you choose one or another, companies charge between $12 and $20 per month for this service.
Get your money right first
Before you invest in your child, remember to take care of who makes it all possible: you.
Otherwise, how are you going to provide a better future? Your ability to help others is the same as the ability to help yourself.
There are two ways to look at it. You can invest now and hope to make enough money by the time they grow up. Or you can invest later, increase your income first, and then invest.
Maybe you hope for compound interest to help their future. But there’s a difference between starting with $500 and $50,000.
While $500 is a good start, it’s much better to wait until you earn enough. Mind that this “investment” is likely money that you won’t be able to touch for a long while. If you invest it in a business or your career today instead, you’re giving money a use: to make more of it, and faster.
If you were already paying “too much” in living expenses, wait until you have kids. There will be more unexpected costs than ever. And it’s only a bad thing if you don’t plan for it.
Don’t underestimate how much money it takes to both raise and invest in your child.
Build their skills gradually
Children rarely deal with large sums of money. What happens when you give them too much? They will likely spend it stupidly.
Just like the lottery winner who loses it all. Or the entrepreneur who never started a business. Or the student who borrows without ever earning a dollar.
Prepare your kids. Teach them how to make and use money. Without this, you can’t secure their future, not even with the largest inheritances.
Here are some ideas:
- The difference between investing and spending
- Personal accounting and how to calculate expenses/deductions
- How to save money or follow a budget
Once they learn how to manage money, they are ready to earn it. And by learning high-demand skills, your children will always make money:
- Market research: Understand what people want and what problems haven’t been solved yet
- Personal finance: How to avoid wasting money while investing for high returns
- Communication: How to influence, sell, or negotiate with people
- High-income skills: Copywriting, sales, SEO, web design
Anyone who masters those skills has an advantage above everyone else. While money is limited, there’s no limit to how much you can earn with your knowledge. Skills pay off forever, which makes them the no.1 investment.
Rather than waiting for the age of majority, you can start early. And nobody said your kids need to master it all at once. It can start as simple as discussing the simplest topics for at least 15 minutes a day.
What You Must Know Before Investing in Children
We’d be foolish to believe that money will solve all our problems. While it does solve many, it also creates other issues. Unless you prepare for these, you’re going to have a hard time with your kids.
Investing in children is questionable by itself. As parents, we want them to have the best life possible. But at the same time, we want them to be independent so that they can live by themselves, not always our support.
Giving money to children creates this conflict sometimes.
- They believe you will always pay for their stuff, so they don’t need to do anything
- If you pay them to do tasks, that can create a sense of entitlement. They may refuse to help your family unless you pay them
- If they never earned nor understand money, they’ll waste it as soon as you give it to then
When gifting money to children, don’t expect them to treat it as wisely as you did. It’s your responsibility to teach how to make better decisions to protect that money.
How to Prevent the Misuse of Your Funds
Luckily, most mistakes are easy to avoid when you’re prepared. Here’s what you can do:
Teach the basics of accounting, saving, and budgeting. Also, teach them how to manage debt and credit in case they ever need to borrow money or finance purchases.
It helps that your kids want to study accounting/economics in college. But they shouldn’t wait for college to learn about money.
Make them work for it
How do you explain to a child the abstraction of money? Teach them what it takes to earn it. This way, they can value it with their time and emotions.
Don’t just give them money. If they learn that earning is hard, they’re more likely to think critically about how to spend/invest it.
This also leads to other questions: How long do I need to work? How long does it take to get rich? Can I make money without spending my time?
So when you teach your kids how to earn, don’t just show them jobs. Show them every possible income stream: product businesses, stock trading, lending, software engineering, freelancing, agencies, subscription models, social media marketing.
Your kids will feel more motivated when they choose how they earn, rather than working because ‘there’s no choice.’
Once they earn by themselves, they’re ready to manage the money you invested in them.
When your kids get money, don’t get too strict on how they should spend those dollars. The whole purpose of earning is to have the freedom to buy whatever you want. And if you took that privilege from them, that may discourage them from earning.
Rather than a penny-pinching mentality, encourage them to earn more to afford everything they want.
But what if they overspend?
They will at first. But if you taught them how to earn and value money, they’ll start to make careful decisions.
If that doesn’t happen, don’t get frustrated. No preparation is going to prevent your children from making mistakes. They do what they believe to be right regardless of the evidence.
If you control their spending, that may help while they live with you. Once they’re adults and move, they’ll follow the same poor habits. Teach without imposing.
All you can do is teach them and know that you’ve invested in them the best way you know.
It’s normal to worry when giving large sums of money. So if you’d like to manage their spending, start with limits.
Set debit card limits
Especially helpful when teaching your kids to use money. You start with a tiny monthly limit and gradually increase it, depending on how they spend it. If they misuse the money, at least you limit your loss.
That’s similar to how lenders work, curiously. How much money you can get depends on your credit score, savings, and ability to repay.
Applied to children, you could raise card limits when…
- They save more than what they get
- They invest in themselves: hobbies, education, tools
- They develop their financial intelligence and skills
Set a custodial account
Parents create custodial accounts and control them until the child reaches the age of majority. After that, it’s all about what the beneficiary decides to do with the money.
If you teach your kids about money the right way, they’ll do well when that time comes. And if you want them to be responsible adults, you should prepare them when they’re children.
While children cannot access the account due to age, that doesn’t mean they can’t benefit today. If you want to motivate your kids, make them feel that that money is actually theirs, even if they can’t see it.
Let’s say your children want to buy something. Two things need to happen:
- They must have enough balance on their (custodial) account
- They need to talk to you and approve the purchase
If it’s a good thing, you’ll naturally give them the money. If it’s a mindless expense, you’ll deny it, maybe propose an alternative.
It’s empowering because they no longer need to be adults to use money. They know you’ll give them money if they have a good reason to spend it.
Which also develops their negotiation skills for the future, whether it’s asking for a raise, selling a product, or raising capital.
Promote the Producer Mentality
The money game is simple:
- Make more than what you spend.
- Give more than what you take.
- Produce more than what you consume.
By default, society encourages consumerism, and for good reasons. It’s simply impossible for one man to be fully independent, which is why we organize in communities. However, one should never confuse interdependence with dependence.
While consumers create debt, producers generate value. It’s a lifestyle which you can teach:
- Promote creative activities (handcrafts, building, writing, drawing, modeling) rather than the passive ones (social media, TV…)
- Don’t buy something you can easily do yourself
- Sell the stuff you don’t use on garage sales or online
- Before you replace a broken product, try to repair it
- Ideally, lend money rather than borrowing
Lure your children to learning
Money rewards can lead to entitlement. And while that may be the kids’ only motivation, it can help them find better ones.
Pay them to learn. Encourage them to explore the world and learn as much as they can. Don’t demand them to be skilled, but to try as many things as possible. They will have fun while becoming more curious.
They first do it for money but end up doing it for the joy of learning. Those who’re always learning typically do great with money.
Educate Children About Money Traps
Money is a massive force in our world, and some people will do anything to get it, good or bad.
- Scammers will make you an offer you can’t refuse
- Marketers will sell you something you don’t need
- Greedy traders will create fake news to distort the market perception (see Pump & Dump)
You never hear about these ugly schemes unless you find out the victims. And if you don’t want to be the next one, you’d better protect yourself as soon as possible.
Where’s the danger?
While it may sound obvious to you, it may not be so much for your kids. And scammers already know the red flags we use to recognize them, so they work extra hard to become undetectable.
The last thing you want is a scammer stealing your kids’ only money. We suggest you share with them some of these schemes:
- Phishing & identity theft
- Fake organizations & services
- Make-money scams & job scams
- Phantom help/advance fee fraud
- Malware downloads
- Payment fraud
The moment the money leaves your child’s account, there’s no guarantee you’ll get it back. Anticipate fraud.
A profit-driven company will sell you their product, whether you need it or not. And if you don’t want to waste money, your kids need to know about these:
- The ‘Latest’ Advancement. Suppose a company has three products solving one need, each better than the other. Rather than only selling the best, they will sell the worst one. After they sell out, they will launch the next ‘revolutionary’ model.
- Bait and switch. A business makes an unrealistic offer that catches your attention. And when you try to purchase, the offer isn’t available. They push you for the standard offer instead. Sellers use baits to stand out from the competition, even when the final price is the same.
- Grace periods. You buy a service because of a 14-day free trial, or because it’s super cheap the first month. ****Sellers hope that you forget to cancel and keep charging you.
- Programmed obsolescence. The manufacturer designed the product to reduce durability intentionally, so you buy a new one again. New versions are incompatible with each other. It costs more to repair something than to replace it.
- Purchase pressure. You get a limited-time discount on some stores. If you buy online, you can find a countdown timer, a limited number of items, and notifications whenever someone buys something. But do you need it?
Consumer traps lead to overspending, which eventually creates debt.
Borrowing money can put you out of trouble if you know how to use it. But why would lenders trust you? They wouldn’t unless the deal benefited them.
They know you have to pay back. And some don’t care about how much it costs you.
Refinancing is a common one. Can’t catch up with your debt? Don’t worry: get a loan for your loan to buy some time. If that’s not enough, borrow more or borrow again.
Even though you may protect your score, you might pay a crazy 30% interest. Enjoy now and pay later may not end well.
Besides predatory loans, other debt traps are payday loans, consumer leases, and debt relief services.
You want your kids to earn for themselves, not to pay off a purchase made a decade ago.
The Bottom Line
Investing in your children can save you a lot of trouble in the future. It’s also an opportunity for them to learn about money, as long as you give them some freedom.
While we need to educate them first, we can’t be too strict. All the time, adults fall for scams, buy things they don’t need and borrow more than they earn. We shouldn’t expect that kids won’t make mistakes.
In the end, only they can decide what to do. What matters is that you prepare them the best you can for the money game.