Raising Money-Savvy Children

When I was in elementary school a thousand years ago, financial education was almost non-existent for children in public schools.  Money and its wise use were seldom mentioned in my classes and not much more in my home.  My parents emphasized the importance of saving, but how to do so and to what future purpose was rarely discussed.  In my family one was expected to save because saving was a virtue, and those who did not save were spendthrifts! Money was simply a necessary evil, and it was just not discussed that much around the children.  Thus, I did not give money much thought until I was in my late teens and discovered that money played a pretty important role in one's life.  I realized that I did not know very much about saving and investing and that I needed to educate myself about money and its uses.  I suspect I would have done a bit better financially early in my adult life if I had received a bit more information about money and finances as I was growing up.  Thus, allow me to make a few suggestions about how parents can help their children learn about money.

 Begin talking to your children about money and the good things it can accomplished while they are young.  By the time children are in the elementary grades they can understand basic financial concepts.  If they hear their parents talking about the importance of saving for the future and sharing with those in need, they will realize that those are important uses of money.  At a young age they cannot appreciate every aspect of the family budget, but they should know that there are some things the family cannot afford, and other things that it can.  They need to know that money is a tool for accomplishing family goals.

As children come to understand the uses of money around age 8 to 9, I believe it is important for them to have some money of their own to manage.  I suggest that they be given some amount of weekly allowance where it is expected that they will give 10% to charity, save 10% for long-term goals like college, save 10% for short term goals such as a new bike or Christmas gifts that they will give, and be allowed to spend the rest as they see fit.  They should be allowed to make some mistakes with money while they are at this age as it will be a great learning experience, and far cheaper than the mistakes they may avoid later.  In part this means that if they "run out of money before they run out of week" they suffer the consequences.

As they enter their teen years and perhaps earn some money at part time jobs, they should be encouraged to learn more about how saving and investing works.  This is a great age for them to open a ROTH IRA with a parent's help.  With supervision this can be a great opportunity for a young person to learn some investment lessons.  They should be involved in determining how this money will be invested, how it can grow, and how it may one day impact them.  By this age they can understand the "magic" of compound interest and how this helps their long-term savings grow.  This is a vital lesson that every parent should emphasize to their children.  As statements from their investment arrive, they should be encouraged to learn what those statements signify and to become actively engaged with their investments.

I believe that it is perfectly acceptable to create some type of incentive plan to help your children save.  Teenagers may not be too enthusiastic about putting money they have earned at work into some type of investment that they will not spend for years, but if dad agrees to match every dollar saved with one or two more dollars, their attitude may well change.  Again, this can be a teachable moment if you help them understand how much this money may grow to be if left to compound. 

College has become one of the greatest financial challenges that a family can face.  Many families simply are unable to guarantee each child that their college expenses will be completely covered for them.  If a child will be expected to help cover a portion of their college expenses with loans, this fact should be discussed openly and early.  The fact that a young adult has helped cover a portion of his college expenses through part-time work and college loans can become a point of pride for them.  It can also be a learning experience and help equip them for life after college.  However, it is important that a young person does not come out of college with such a heavy burden of debt that they cannot possibly repay it with their expected salary.  Some college degrees have simply become more expensive than they are worth, and that is an entirely different discussion to be had. 

 Children who are exposed to financial lessons and the way money works at an early age are naturally better equiped as adults to deal with adult financial issues.  They will understand that only those who have saved and planned are likely to have an excess from which they can share with others.  They will arrive at adulthood realizing that there is a difference between "frugality" and being "cheap."  They will understand that money is a gift from God and a tool with which we are to do good.  I encourage you to talk with your children, your young children, about money and all the good things it can accomplish.

Fly/Drive Safely

22 December, 2011

Inherited IRAs; Be Very Careful How You Handle Them!

IRAs have proven to be excellent vehicles for retirement saving.  They also occasionally end up in someone’s estate following their death, and they then become someone’s  inherited IRAs.  This is an excellent way to pass benefits to heirs, but there are some fairly complicated IRS rules that must be followed if the benefits are to be maximized.  Let’s look at a few examples.

A spouse inherits the IRA

A surviving spouse who inherits an IRA has more flexibility than other beneficiaries.  They can choose to keep the account in the name of the deceased and remain the beneficiary.  They can then take minimum withdrawals based on their own life expectancy while the account balance continues to grow tax-deferred.  Note that beneficiary’s withdrawals are never subject to early-withdrawal penalties, regardless of his or her age.  This could be a good choice for a younger spouse who needs current income.  Another choice would be to transfer the balance of the inherited IRA into an IRA held in their own name.  As the owner they could then make additional contributions to the account and postpone taking any taxable withdrawals until they reached age 70 and ½ when required minimum distributions (RMD) would begin.  Of course if they withdraw any funds from an account in their own name prior to 59 and ½, a 10% early withdrawal penalty would apply.  And third, they could always simply withdraw the entire balance and pay the required taxes the year the balance was withdrawn.  This is seldom a wise choice.

A non-spouse inherits the IRA

If you inherit an IRA from anyone other than your spouse, a parent for example, you have to begin taking distributions by December 31 of the year after the original owner’s death.  You will remain the beneficiary and are allowed to stretch those yearly distributions, which are taxable of course, over your entire life expectancy (based on an IRS table); but you can never become the owner of the inherited IRA.  If you were to commingle the funds from an inherited IRA with an IRA owned in your name, you have just created a very expensive taxable event.  This you want to avoid!  To avoid a taxable event with the entire balance, you will need to transfer the assets into a beneficiary distribution account, also called a beneficial IRA.  It remains an IRA, with both your name on the account as beneficiary and the deceased person’s name as the original account holder.  Example:  “John Smith IRA (deceased September 12, 2009) for the benefit of Susan Smith, beneficiary.”

Insure that the financial institution does not put the IRA directly into your name, or cut you a check for the balance.  Again, either of those mistakes can result in that nasty taxable event. You may make a “custodian-to-custodian” transfer and move the account from, for example, Schwab to Vanguard, but do not allow the original custodian to issue you a check.  This is very important if you want to avoid that nasty tax bill.   Of course, you may cash out the account so it is no longer an IRA.  This makes all of the money income for you in the year you cash it out.

IRA owners should always designate a beneficiary (as well as contingent beneficiaries) for their IRA accounts.  Generally, the beneficiary should be an actual person rather than an estate or a trust.  (An exception could be made for a precisely worded trust for a minor or handicapped child.)  An IRA inherited through a will or a trust can become taxable much sooner and offer fewer options to those inheriting it.

Inherited IRAs are governed by very strict and complicated tax rules.  Failure to comply with these rules can greatly decrease the benefits that the original owner of the IRA would have surely wanted you to have.  Go slowly and insure that you understand all of the tax ramifications that come with an inherited IRA.

If you are having trouble sleeping some night, you can review all of the IRS rules for IRAs here:  http://www.irs.gov/publications/p590/ch01.html#en_US_2010_publink1000230538