Laura answers a listener's questions about how to find a trustworthy financial advisor and give a young child financial freedom.
Laura answers a listener's questions about how to find a trustworthy financial advisor and give a young child financial freedom.
Money Girl is hosted by Laura Adams. A transcript is available at Simplecast.
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Welcome back to Finance Friday, another special edition of Money Girl, where I answer your burning money questions! Today's topic comes from Ashley C., who says:
"Hi Laura, my name is Ashley C. I can't thank you enough for all the incredible content you share with us. I'm a 33-year-old new mom to a little six-month-old girl and a researcher at Microsoft. I have two questions.
The first is trying to figure out how to sift through financial advisors who may or may not be fiduciaries and ask them questions to know if they will be a good fit and give honest advice. It would be really helpful to hear how you know you can trust them through a series of questions to compare notes.
The second question is about setting up my daughter for financial freedom. What accounts and strategies do you recommend to get her up and running? So far, I'm setting up a 529 plan.
I really appreciate all of the work that you do. You're contributing to lives that will be better off because of the education that you afford us all to have. Thank you again!"
Thanks for your generous words and great questions, Ashley! First, this post will review several excellent ways to invest for a young child, giving them a secure financial future. Then, I'll discuss how to find the right financial advisor.
I appreciate you listening to episode 885 of the Money Girl podcast! I'm Laura Adams, an award-winning author, female financial speaker, money spokesperson, and consumer advocate. Please reach out if you're interested in collaborating for a speaking event or PR campaign!
As always, you can reach me using my contact page at LauraDAdams.com. That's also where you can sign up for my free Substack newsletter, The Money Stack. Subscribers get my Money Success Toolkit, which includes a Financial Planning Workbook and Personal Financial Statement calculator to assess your financial situation, set goals, and track your wealth!
I'd love to feature your money question! Send it by email using my contact page at LauraDAdams.com or calling 302-364-0308, just like Ashley did.
4 ways to make a young child wealthy
If you're a parent, saving for your own financial goals is essential before setting aside money for your kids. Of course, you want the best for your children, but you must also make wise decisions for your financial future. If you can genuinely afford it, here are X excellent ways to invest for a young child's future.
1. Contribute to a 529 plan.
Opening and regularly contributing to a 529 college savings plan is a great way to pay a child's future education expenses. So, I'm glad that Ashley mentioned doing that already. It's a good choice since most families will have school expenses.
What I love about a 529 plan is that you can contribute on any schedule and choose investments from a menu of options, such as mutual or exchange-traded funds. You can use a 529 no matter how much you earn, and the maximum annual contribution limit depends on the plan you choose, but it could be over six figures per student.
You can make tax-free 529 withdrawals to pay qualified education expenses, such as tuition, fees, books, required equipment, and room and board. Funds in a 529 plan can be spent at U.S.-accredited schools and certain foreign institutions. For example, you could live in Florida, participate in a New York 529 plan, and use the funds to send a child to college in California or Germany.
Thanks to the Tax Cuts and Jobs Act, you can also spend up to $10,000 per beneficiary per year tax-free on elementary and secondary school expenses. That allows parents to withdraw funds for a younger child attending a public, private, or religious school.
Note that funds in a 529 belong to the owner (typically a parent), and the account can have one designated beneficiary, the future student. To save for more than one child, you must generally open an account for each. However, you can also change a 529 beneficiary to another family member or roll it over to another 529 without triggering taxes.
Another new option created by the SECURE 2.0 Act allows you to roll over unused 529 funds to the beneficiary's Roth IRA–if they qualify for one by having earned income. But there are several restrictions you must follow. For instance, the 529 must have been open for at least 15 years, and the lifetime rollover limit is $35,000 per beneficiary. Also, you can't transfer 529 contributions (or their earnings) made in the past five years.
Due to the benefits of a 529, including tax advantages, flexibility, and high contribution limits, it's an excellent account to save for a child's education. Additionally, your 529 funds are a smaller factor in the calculation for financial aid than some other options.
The main drawback of a 529 is that if you withdraw funds for non-qualified expenses, you must pay income tax plus a 10% penalty on the portion attributed to earnings. So, try not to put more in a 529 than you believe your child will need for school. If you have more money to invest, use one or more options I'll cover next.
2. Open a custodial account.
In most states, minors can't own investments or any financial products in their names. Therefore, you can only transfer assets to a minor if you create a trust or open a custodial account known as a UGMA (Uniform Gift to Minors Act) or UTMA (Uniform Transfer to Minors Act).
You can set up a UGMA or UTMA account at most banks and brokerage firms. These special accounts allow you to make investments on behalf of a child, like buying mutual funds or real estate. The account gets held by a custodian, which can be a parent or someone else, but is legally owned by the child.
Parents can withdraw from a child's custodial account to cover expenses that benefit them, such as the child's education and healthcare. The account assets automatically transfer into their name when the child is an adult (usually at 18 or 21).
The main benefit of using a UGMA or UTMA account is giving a child as much money or assets as you like. There are no annual limits or spending restrictions. Plus, a portion of the account's investment earnings gets taxed at your child's income tax rate, which can reduce taxes.
Since putting money in a custodial account is a gift from a parent to a child, it comes with potential gift and estate tax implications. However, it's easy to avoid triggering the federal gift tax by contributing at most $18,000 annually as a single taxpayer or $36,000 as a married couple filing joint taxes for 2024. You may not owe gift taxes if you exceed those limits; however, additional gifts would count toward the lifetime gift-tax exclusion limit of $13.61 million for 2024.
The downside of UGMA and UTMA accounts is that once the child reaches the age of majority, parents have no control over how the child spends it. Also, custodial accounts are considered an asset of the child, which means they're a more significant factor in the calculation for financial aid than accounts owned by a parent, such as a 529 plan. Plus, unlike a 529, custodial accounts don't receive tax benefits.
RELATED: Roth IRA Rules for Minors–How to Make Kids Millionaires
3. Use a brokerage account.
If you want more control over investments for a young child than custodial accounts allow, consider opening a brokerage in your name. You can always earmark money in an account for a child.
That way, you can access the funds until you give them to your child when they become an adult. Or you can keep the account in your name and make a child the beneficiary if you die.
The flexibility is the upside of investing for a child in your own brokerage. The downside is paying taxes on earnings at your tax rate rather than your child's rate, which is typically much lower. As I mentioned, you also must be mindful of the gift tax rules if you give a brokerage account to a child.
READ ALSO: 8 things to know about investing in a brokerage account
4. Purchase life insurance.
In addition to investing, you can ensure a child's financial future by purchasing life insurance. Every parent should have a life policy so their minor children would be financially secure after their death.
Life insurance is a contract that pays one or more beneficiaries after your death. Depending on your budget and needs, you can choose term or permanent policies.
Term life insurance pays your beneficiaries a cash benefit if you die within a period, such as in 10 or 20 years. A permanent life policy covers you for your entire life and may also accumulate a cash value you can tap or grow for a child.
If you're relatively young and healthy, a $500,000, 20-year term life policy may cost less than $300 a year. If you get life insurance through work, that's terrific, but you may need more. Depending on your financial needs and family size, having life coverage equal to ten times your income is a good rule of thumb.
Also, remember that if you leave your job for any reason, your life coverage ends. Therefore, it's wise to have your own life policy in addition to the coverage you get through an employer.
The downside of buying life insurance is that it typically only benefits your child once you die. However, if you have a permanent policy that builds cash value over time, you could tap it to pay expenses, such as for a child's education.
ALSO LISTEN: Who should buy cash value life insurance?
How can I find the right financial advisor?
Before you choose a financial advisor, get familiar with the following types based on how they get paid.
However, many financial products, such as life insurance, are always sold on commission through a licensed broker. So, paying a commission to an advisor isn't necessarily a poor choice as long as you understand if there's any potential conflict of interest.
Other advisors may work exclusively with clients to create financial plans and charge flat or hourly fees ranging from a few hundred or thousand dollars.
What financial advisor certifications should I look for?
Another aspect of working with financial advisors that needs to be clarified is their various professional certifications and designations. Here are several you should know:
Which type of financial advisor is best for you depends on factors like how much you have to invest, the products you want, and the services you need, such as investment management, business advice, or tax preparation. Some investment advisors only work with high-net-worth individuals or pre-retirees, but many accept smaller portfolios.
How to find the best financial advisor
To find the best financial advisor, you might get a recommendation from friends or family or search online. Various organizations, such as the National Association of Personal Financial Advisors, Certified Financial Planner Board, and Garrett Planning Network, allow you to search for and verify the credentials of certified professionals in your area and nationwide.
You can research any advisor's status and background using the SEC's Investment Advisor Public Disclosure and FINRA's BrokerCheck database. That's an important step to ensure no disciplinary actions or significant complaints were filed against them. You can also do a Google search for a professional's name plus words like "complaints" and "disciplinary actions."
What questions should I ask financial advisors?
Once you find one or more potential financial advisors, meet with them in person or over a video call. If you're married or share your financial life with a partner, you should both meet with a potential advisor. Be prepared to discuss your income, expenses, investments, and financial goals.
Ask each advisor the following ten questions and take notes about their answers, personality, and how they made you feel during the meeting.
Ashley, I hope this helps you give your young daughter a great financial head start and find a great advisor. Remember, you can always change advisors or firms if a relationship turns out differently than expected. No matter if you're starting to invest or are approaching retirement, using an expert advisor can help you avoid money mistakes, maximize returns, and follow a sound financial strategy.
That's all for now. I'll talk to you soon. Until then, here's to living a richer life!
Money Girl is a Quick and Dirty Tips podcast, and I want to thank our fantastic team! Steve Riekeberg audio-engineers the show. Brannan Goetschius is our director of podcasts, Holly Hutchings is our digital operations specialist, Morgan Christianson is our advertising operations specialist, Davina Tomlin is our marketing and publicity associate, and Nathaniel Hoopes is our marketing contractor.