If you're a parent, setting your child up for future financial success is among the many considerations you have when it comes to managing your funds. But what are the best ways to go about ensuring your children are rewarded for your efforts down the line? We chatted with Leanne Rahn, Fiduciary Financial Advisor with Fiduciary Financial Advisors, to learn more.
Parents who are in a financial position to save for their child's future, Rahn explained, have the power to lay a solid foundation, whether through higher education savings, general savings or retirement savings. And while timing may vary based on one's own individual financial goals and situation, getting started sooner rather than later is recommended.
"If parents are taking advantage of putting their child's long-term savings into investment vehicles, compound interest will be on their side," Rahn said, noting the two most common mistakes parents can make are not prioritizing their own financial health and failing to utilize investment vehicles or vehicles earning more than bank rates. "Assuming we're talking long-term savings, having the savings be complacent in cash is really working against them. Inflation will eat away at the savings over time, leaving parents with less purchasing power when the time comes to use the funds. Investing doesn't always have to mean extremely risky and scary."
Rahn outlined some of her favorite ways parents can save for their child's future:
"This is a tax-advantaged account where earnings grow tax-free (federal and state) if used for qualified education expenses," Rahn said. "Additionally, in Michigan, up to $10k a year in contributions are state
tax-deductible (if married filing jointly; $5k a year if filing single). The main intention for this account would be saving for your child's future education and parents can reap great tax benefits from this vehicle. If funds are not used for education, the distributions will be hit with a 10% penalty, plus taxes will be due."
The list of qualified educational expenses under this plan has grown to include books, supplies, software, primary or secondary education (rules apply), certain room and board expenses, and more.
"The 529 Plan is a great tool to grow long-term education savings while receiving tax benefits and it can provide additional flexibility with any unused funds," Rahn said.
While primarily thought of for retirement, a Roth IRA can also be a savings vehicle for your child's future. Because Roth IRAs are funded with after-tax dollars, owners have the ability to pull contributions at any time (tax and penalty-free) before the standard age of 59 ½.
"The key word here is contributions, not earnings. If a parent is thinking about using Roth IRA funds for education purposes, earnings can be pulled without penalties, however, taxes will be due," Rahn said. "Keep in mind that Roth IRA distributions will count as income for FAFSA purposes and can affect the amount of financial aid a student receives."
"Otherwise known as a Custodial Brokerage Account, a UGMA/UTMA is an account where savings can be used for any intended purpose, as long as it's in the benefit of the minor," Rahn said, sharing examples such as car savings, future business savings and education opportunities. "Note that UGMAs/UTMAs do affect financial aid ability and don't have special tax-advantages as it relates to education (like the 529 Plan or Roth IRA vehicles do). The tax benefit they may provide is not at the time of contribution, but rather at the time unearned income has been generated."
While these account types offer flexibility with your intention with the funds, it's important to note children gain full control of UTMAs/UGMAs once they reach the majority age of 18 in Michigan.
"If parents aren't comfortable giving their child full autonomy and control over their savings at the legal age, then this may not be the best savings vehicle," Rahn said.
According to Rahn, working with a fiduciary financial advisor can provide confidence, structure, and guidance on how to best grow your child's savings and ensure the plan is aligned with the timeline, risk tolerance and overarching goals.
"The biggest thing I'd encourage parents to consider before deciding on a vehicle is what they want the savings to be intended for," she said, adding that parents have a large influence on how children view money. "If we think about our own stories with money and how it was (or wasn't) talked about growing up, I guarantee it affects how we handle money today."
Written by Sarah Suydam, Managing Editor for West Michigan Woman.
This article originally appeared in the Oct/Nov '23 issue of West Michigan Woman.
The information contained herein has been obtained from a third party source which is believed to be reliable but is subject to correction for error. Fiduciary Financial Advisors LLC does not give legal or tax advice. The information contained does not constitute a solicitation or offer to buy or sell any security and does not purport to be a complete statement of all material facts relating to the strategies and services mentioned. Past performance is not a guarantee or representation of future results.