Do you want to build wealth for your children?
Here are 4 effective ways to do so:
529 account
A 529 account is one of the best ways to invest for your child.
It offers two benefits:
- Tax-free withdrawals for qualified education costs.
- Often state tax-deductible.
For example, say you put $10,000 into a 529 plan.
Depending on the state, you might receive a deduction, saving you anywhere from $200 to $1,300 in taxes, depending on your rate.
By the time your child is ready for college, the amount may grow to $30,000.
You can use that $30,000 for qualifying educational costs without paying any taxes.
โBut what if my child skips college?!โ
If the 529 plan has been open for at least 15 years under a specific beneficiary, you can convert up to $35,000 to the Roth IRA. So, itโs best to open a one 529 plan for one child.
Brokerage account
You can also open a brokerage account and invest in it for your child.
The main benefit of a brokerage account over a 529 is that you can withdraw the invested amounts for any reason, not specifically for educational expenses.
Additionally, brokerage accounts allow you to invest in a broader range of assets, while a 529 plan could be limited depending on your state/option.
I personally believe that you should diversify between a 529 and a brokerage.
Roth IRA
You cannot contribute to your kidsโ Roth IRA unless they have earned income.
So, if you are a W-2, there is nothing you can do about it. But, if you are a business owner, you can put them on payroll.
There are a few rules to keep in mind:
- Reasonable wages based on the job
- Tracking the hours and duties
- Actually paying them for the work
- Filing W-2 and payroll reports
A few examples Iโve seen are scanning documents for a tax firm or modeling for a social media account.
This will allow your business to get a tax deduction, and since your child will be generally below the standard deduction, pay $0 in federal taxes.
Then, you can contribute to a Roth IRA for your child. Imagine 50+ years of compounding growth in a tax-free account? That is a wealth builder for your child.
Bonus tip: Roth IRA amount is not counted towards FAFSA for your childโs education.
Trusts
This is a more advanced strategy and generally isnโt recommended for taxpayers with less than a $5M+ estate, but you could set up an irrevocable trust and transfer $19,000 (the maximum gift annual limit to avoid impacting the estate exemption).
What this accomplishes is that it removes $19,000 from your personal estate (taxed at the maximum rate of 40% when your next kin inherits the money if the estate exceeds the annual exemption amount of $14M) and puts it into a trust.
So, effectively, you are saving a maximum of 40% of federal taxes (plus some state taxes) on the amount gifted.
You would need a qualified lawyer and incur additional fees and compliance to set it up correctly, but it’s certainly worth it at that net worth level.
I hope you enjoyed this one.
See you next Saturday.
MC, CPA