By: Paul Morrone
Gifting is always a hot topic in the office. From helping children with down payments on homes to gifting them money to fund ROTH IRAs, the possibilities are virtually endless. My opinion, however, is that the best gifting plan bridges the role of benevolent parent and financial educator by teaching kids to be good stewards of their own wealth (and your wealth, once they inherit it after you’re gone). In a world that is addicted to – and demands – instant gratification, we know that building wealth can take a lifetime. The ultimate deferred gratification.
Consider this: most of today’s children are going to obtain wealth in one of two ways – they will work hard and earn in the old-fashioned way through disciplined savings and investing plans, or they will inherit it. A small minority will build or buy a company, but those are the exceptions, not the norm. So, if most people are going to earn or inherit, why not teach them early on some of the key fundamentals that our public education system seemingly neglects? If you agree, your next question is likely, “how should I go about it?”
Set goals: The first step is committing to a plan and figuring out what goals you have for you and your child. Remember a gifting plan always has two parties – the gift giver and the recipient – and the goals should be aligned. Higher net-worth individuals may want to gift to reduce the amount of their taxable estate, whereas those with estates $10mm or less may not be as focused on wealth transfer for estate tax minimization purposes. In virtually all instances, however, the parent or grandparent making the gifts may want to fund a specific goal for a child or grandchild (for example: education, housing, business seed money) or help to give a loved one a financial head start building their own nest egg.
From the child’s perspective, and age will play a lot into this, the goal will change over time. A young child (say less than 12) may benefit from doing chores and working for the money they earn – which you, in turn, can help them save and invest. This is also an opportunity to teach budgeting and the value-for-dollar concept, which children always struggle to understand. And for those charitably inclined, help them understand how giving money, goods, or even volunteering their time can help those that are less fortunate. I always have my young children buy a toy from their ‘own’ money for our holiday toy drive each year to reinforce this concept. Simple, but effective.
A more mature child may want to get their feet wet with investments, and gifts from family are a great way to help them jumpstart something they may not have the discretionary income to do on their own. As many will gravitate to investing in companies they know, they will be able to see firsthand how the share prices of companies like Apple, Amazon or Google change and how wealth can multiply with the right strategy in place. This will also give them perspective on how investing small sums on a recurring basis can add up to big numbers if you commit to a plan and execute over time.
Once the child gets older, you can teach them how to set their own goals to give them a sense of discipline and reward. Maybe it’s something trivial like attaining certain account balance by a certain age. Maybe they want to save for a car when they turn 18 or 21, or take college spring break with friends. The most ambitious ones will think beyond that and may be thinking about a house when they get out of college.
Do the math: With goals aligned and budgets set, the next step is where the rubber meets the road, and where many fall short of illustrating the power of time and investing. There are plenty of online calculators that are simple to use and will be helpful here. Let them see the numbers and play with the inputs. How much it would take per month, assuming a rate of return of X% (use something reasonable 5-8% for starters), to achieve an ending value of $Y by a certain date.
Let them see the numbers: This is where things get exciting, and frustrating at the same time. Watching account balances change too frequently can feel like watching grass grow, especially when the numbers are nominal. Semi-annual or annual check-ins will help more properly frame the long-term mindset and allows enough time for account balances to change meaningfully enough to garner some interest. The more analytical children will want to pull back the curtain to see what is doing well and what is not within their investment portfolio, which will help them understand the concept of investment performance and how it can differ by company or asset class.
Talk taxes: This may be beyond the gifting conversation, but it is such an important part of personal finance I would be remiss to leave it out. For many households, taxes are the biggest expense they don’t talk about, likely because parents don’t fully understand it either. Working age children can benefit from a review their paychecks. Teach them the basics about taxation (payroll vs income tax). If they are too young for a paycheck, the simplest way I’ve learned to explain tax to a young kid is through food. Buy them an ice cream bar. Before they get their hands on it, take a bite out of it. Explain that you get a piece of their ice cream bar because they live in your house which is expensive run and that 70% of that ice cream bar is better than not having an ice cream bar at all. Again, simple, but effective.
Get advanced: Putting together a basic portfolio can help a child learn so many things about investing. Diversification, risk of loss, taxation and an understanding of capital markets are concepts that every individual should have a base level of proficiency in. Some may even enjoy it. This can also help reinforce the savings and budgeting conversation to ensure that children remember to always allocate a portion of their gift (or income) to a bigger picture goal. And it also helps them to get familiar with the various account types they will encounter in their working lives – IRAs, ROTHs, 401ks, individual brokerage accounts, etc. – to give them a baseline knowledge about how they differ in terms of their funding, investment offerings and tax structure.
Finally, don’t be afraid to ask for help. We help our clients navigate these conversations with their children all the time, and we are often entrusted to work directly with our clients’ children to discuss these very topics. Being a parent myself, I very much understand that children are much more likely to listen to someone that isn’t their parent and we’re happy to be the objective/professional third party to help them begin their financial lives on the right foot. However you choose to execute, make sure you have a plan and have fun doing it. Giving the gift of money is nice, giving the gift of education is priceless.
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