Starting Out Strong – How To Help Your Children Achieve Financial Success
Opening a 529 college savings plan and contributing to it regularly can make a big difference in your children’s lives—and so can setting up their own Roth IRA, which will give them a jump-start for the future.
As a parent, your natural instinct is to want your children to realize their full potential with rewarding careers and financially stable lives. The path to opportunities before them often begins with a college education—a financial goal you and your children can reach with some forethought and a regular savings plan. Helping to pay for the costs can give them a significant advantage—the majority of student aid comes in the form of loans that will have to be paid back, meaning you or your children would have to handle debt in the future to finance that important gateway to success. “New parents can start saving for their children’s higher education in a 529 plan as soon as they’re born or even before they’re born,” says Judith Ward, CFP®, a senior financial planner at T. Rowe Price. “Parents with older
pre-college children also have a valuable tool available to help their children get a jump on their retirement savings—a Roth IRA that can potentially grow to hundreds of thousands of dollars or more over the course of their lives.”
On Course for College
A 529 college savings plan is one of the first things, financially, that you can do as a new parent to help your child. The account grows tax-deferred, and any earnings are free from federal tax, and in most cases state tax, provided you use the money for qualified higher education expenses. You can start a plan regardless of income level, and anyone—including relatives and friends—may contribute to it, up to a limit established by each plan (generally ranging from $235,000 to $380,000). Any unused money in one child’s account can be used to benefit another member of the beneficiary’s family. If you distribute the money for anything other than qualified educational expenses, you’ll have to pay taxes and a 10% penalty on any earnings. Says Ward, “A 529 savings account is a great vehicle to stay ahead of the rising costs of college and reduce your need to borrow money when your kids head off to school.”
Rules for Roth IRAs
One of the best ways to inspire your children to save and think about their future is to help them set up a Roth IRA. With some earned income from jobs such as mowing lawns or babysitting, your children can have a retirement account opened for them. Contributions are made with after-tax money, and earnings are free from taxes for withdrawals made after age 59½.*
And you can make contributions on their behalf—for example, you may choose to
contribute a certain amount to their accounts each year based on their wages, up to a maximum of $5,000 in 2012. “The Roth IRA is a great account because of the flexibility it provides,” Ward says. “Saving for retirement might seem foreign to young people—and they’re probably not even thinking about what kind of account they should have. But once they understand how much their money can grow, saving can be very exciting to them.”
Becoming Money Smart
Planning for the cost of college is a great opportunity to talk to your children about investing and financial goal-setting. “They’ll see firsthand how important it is to prepare for a major expense,” notes Ward. And opening and contributing to a Roth IRA is a practical way to get your children thinking about their futures beyond college, while witnessing the powerful benefits of saving. “Actively engaging with and involving your children in appropriate and relevant financial matters can be the most effective way to help them to become invested in their future,” Ward says, “setting them up for financial success.”
Please note: A 529 plan’s disclosure document includes investment objectives, risks, fees, expenses, and other information you should read and consider carefully before investing.
*Withdrawals of principal are always income and penalty tax-free, and withdrawals of earnings from Roth IRAs can be made penalty-free, provided the child opened the account at least five years earlier and the money is used for exceptions such as a first-time home payment up to the lifetime limit of $10,000 and certain unreimbursed medical expenses.