By Dr. James M. Dahle, WCI Founder
A lot of blog readers asked me questions a few months ago in the “Windfall Post” where I made an off-hand comment about the “20s Fund” I'm saving up for my children. I thought this would be a good opportunity to talk a little bit about the inheritance I am saving up for my kids.
Now, I expect there will be quite a bit left when we're dead. I'll probably keel over in my 80s but I fully expect my wife to be a centenarian. So that means by the time she goes the kids will hopefully be retired and financially independent before they get any kind of final inheritance from us. Receiving money at ages 60-75 isn't going to do them any good, and I'd like to actually do them some good.
Avoiding Economic Outpatient Care
Stanley and Danko in the classic personal finance book that I hope you have all read, The Millionaire Next Door, spend an entire chapter describing how wealthy people ruin their children, both morally and financially, by giving them money as adults. I believe the data they compiled. So the key for me is to help my children without ruining them. I have spent a lot of time thinking about this, and this post demonstrates the plan so far.
My Children's Inheritance: The Five-Point Plan
Financially speaking, I plan for my children to get their “early inheritance” in five different ways.
#1 Give My Children Financial Knowledge
One of the very best ways I will help my children is to pass along financial knowledge. My 11-year-old has known that interest should be received, not paid, for years. She knows how a Roth IRA works. She tells her friends that she wants to either be a back surgeon or a financial advisor because she knows both of those careers make a lot of money. She groans when I turn on Dave Ramsey, but she's gotten the message. As we drive around town I point out to her all the businesses she owns—you know, McDonald's, Home Depot, Lowes, Disney, Chevron, etc.
Now I'm starting with her younger siblings. I opened bank accounts for them recently and they've had investing accounts for years. They know that there has to be money behind checks and credit cards. I have no doubt they will be very unique among their college peers with respect to their financial knowledge. And that is totally free to pass on to them.
#2 Contribute to Their 529 College Funds
Most well-to-do parents try to save something up for their children's educations. In fact, I have run into many of you that are planning to save up way more than I am for college. Part of that comes from the fact that my wife and I attended very inexpensive undergraduate and graduate schools. Part of it is the fact that I don't intend to pay for their entire educations. As I've written before, I expect them to contribute in a number of ways:
- Choose a reasonably priced school for their goals and abilities
- Earn merit scholarships
- Work during school and in the summers
They also will benefit from an education fund provided by their great grandparents. Like the money I am saving up for them, that fund won't completely cover their education, especially if they go to graduate or professional school. But combined with what I will have saved up, and what they contribute, my goal is to get them out of their undergraduate educations completely debt-free, and if desired, through their graduate/professional educations with a manageable amount of debt.
She's not very good at keeping her feet dry while backpacking, but she can rock a future value function.
The fund I am saving up for them is in the Utah 529 Plan, the UESP. It's a great plan, with low expenses, a state tax credit for residents like me, and both Vanguard and DFA funds. I invest the money in a very aggressive asset allocation—100% stock (50% international and 50% small value) for reasons I discussed here. Although I jump-started the infant's fund with $10K, I generally only contribute enough to get the maximum tax credit each year, about $4K per child. Obviously, that's not going to be $250K a piece when they hit college age, even starting early as we did.
#3 Invest in a UTMA/UGMA for Their “20s Fund”
In my opinion, the most useful time in life to receive an inheritance is in your 20s. That's when you have precious little earning power, zero net worth (at best), and tons of expenses. Everybody thinks of college, but there are also summers in Europe, missionary work, a first car, a down payment, a wedding, and a honeymoon. For the professional student, there might be nearly a decade spent without a significant income. So we have decided to save up some money for this important decade to help our children. Not only will this fund provide them some unique opportunities and help them not start out life heavily in debt, but it will allow them to make decisions from a different perspective than I had to.
For example, I was donating plasma in college in order to get by. When we were engaged and planning to get married just before my MSI year, I was sick of being poor and did not want to drag my wife through the existence I had been enduring for the previous several years. I'm sure that factored heavily into my decision to sign-up with the military for medical school.
Now, I like to think that wasn't my primary motivation. Certainly, I had some motivation to serve my country. I was definitely looking for an adventure (which I never really found to be honest in an environment where we weren't allowed to leave a base in rural Chile for “security reasons”). However, there's no doubt the idea of someone just handing me $920 a month throughout medical school AND covering tuition, books, and fees was very attractive given that I had been living on $5000 a year up until that time.
It would have been nice to have been a little bit more financially secure in my 20s. I think I would have made some decisions a little bit differently, and hopefully for the better. Granted, there is a fine line between Economic Outpatient Care and financial security, but I don't think our kids need to feel quite the pinch I felt in order to be financially successful.
Only 8 and a millionaire in training
This money is invested in a UTMA/UGMA account. Also 100% in stocks. I've only started it for the eldest but hopefully will get the others started in the next year or so. How much money will be in this account? At least $10K and certainly less than $50K. That won't cover a ton, but it will cover some things. UTMA/UGMA accounts, unlike 529s, become theirs as soon as they turn 18 (21 in some states). So if they decide to blow it all on heroin, there won't be anything I can do about it.
#4 “Daddy Match” Roth IRA Retirement Fund
Every dollar my kids earn as children and teenagers goes into a Roth IRA thanks to the “daddy match”. What's a daddy match? That means the money (babysitting, mowing lawns, teen summer jobs, etc.) they earn goes into the Roth IRA and I give them an amount equal to it to spend on whatever they like. That does mean we've got to deal with the hassle of their tax returns, but it's totally worth it (and kids can earn a ton without paying much tax at all). Besides, it gives them a chance to learn all about the tax code.
In fact, all of my children are employed by this website. You see those photos of them all over the site? You think they're giving me their time and images for free? Heck no. The going rate for child models is $100 an hour. That's $100 I don't pay taxes on, $100 they don't pay taxes on, and $100 that can go into a Roth IRA and compound for the next 6-8 decades (double that if properly stretched).
I just see a Roth IRA as too good of a deal to pass up. I don't know how much money we will get into their Roth IRAs before they hit age 18, but even if it is only $10K, if it grows at 5% real for 50 years it will be worth $114K. And the lessons of investing from the very beginning are worth even more.
#5 Encourage Them to Own a Business
Now, this one I can't say I've actually started for any of them yet. But imagine with me if you will a child whose college fund doesn't consist of a fund invested in stocks, bonds, or CDs. Instead, it is a business.
Imagine graduating from high school with a business that pays you $5K, $10K, perhaps even $50K a year of passive income. Maybe it is a rental property. Maybe it is a website. I don't know. But what better way to “teach a person to fish” than to have a kid learn how to run a business in middle and high school?
There is no reason someone can't be a high-income professional (or an artist, or a teacher, or whatever) AND an entrepreneur on the side. I hope to plant those entrepreneurial seeds early in my children. Stay tuned for further details on this one.
Well, that's my plan. It's still a little rough around the edges, and it is likely to see some significant changes in the future. But better to have any plan than no plan at all.
[Editor's Update: It's been a few years since this post was originally written so here's an update. We're doing great with # 1. As near as I can tell, my kids are among the most financially literate of their peers. We're also way ahead on # 2. As our income increased, we are also increasing how much we're saving for school for the kids. It still won't be $250K, but given the average cost of the universities in Utah, $250K could cover both tuition and living expense for undergrad and med school. # 3 is also a check. These are funded but we still add money there occasionally. # 4 The Roth IRAs continue to grow with every dollar they make from WCI and any other paid work they do. # 5 No luck here yet, other than some lemonade stands, but the eldest did manage to hold down a job this summer, so there were lots of lessons to learn from that. ]
What do you think? Do you plan to give your kids an “early inheritance?” How and why? If not, why not? What are you doing? Comment below!
One of the biggest gifts that you left out;
Not becoming a financial burden on your children.
I did not get any of the points you made but would just be happy with parents who could remain self sustaining.
I hope to provide similar support for my children as you describe.
Teach them right
529 that is able to cover a state undergrad education
I have not started a UTMA but may consider it.
I think the Roth IRA idea is a good one. Hopefully we can instill that this money is for retirement and not to be spent early.
As for number 5 I think it takes the right kid of person to be an entrepreneur. My children are too young to tell at this point but I will keep it in mind.
Thanks for the repost!
An excellent point and the main reason why retirement savings should be prioritized over college savings.
Great post. Remember when if first came out.
My wife and I are both docs so we do have the luxury of a comfortable income.
We follow pretty much exactly what you do, with the exception of we probably need to be showing and/or teaching our kids more about each of the above like you have. The only one i can’t do is the Roth’s for the kids, as i am in a group practice so it’s kinda hard for me to employ just my kids without the other partners involvement.
We did start a “20’s” custodial fund like you did for each kid, but we actually did it at birth along with their 529’s which were also started at birth for each kid. We should hit the $200 -250k number for each kid in their 529’s, and we have been putting 110$ into their “20’s” fund (we called it the marriage/house downpayment fund) each month, and it should reach between $50-70K by the time they are in their late 20’s, which is the earliest I hope they get married or use it for a 1st house down payment. I am a little concerned about them having access to that kinda skrill at age 18 so I was kinda thinking of not even telling them about it till their mid 20’s, but then that negates the ability to use it as a teaching tool so they can watch it grow.
You can still do Roth IRAs for their lawn mowing, babysitting, summer job kind of income.
I’m starting to feel more and more strongly about leaving an inheritance, if we can swing it. Looking at the world we live in today, friends stressed out about their careers, money, or getting burnt out. Parents or kids themselves pushing hard to get to the top and be “successful.” A lot of what I see I don’t necessarily want for my child and I believe leaving an inheritance and giving them financial security will aid in this. Of course, I want them to have a good head on their shoulders, but I don’t want them stressing about getting to the top, having to make lots of money or overworking themselves.
Not 100% sure of how we’ll approach it yet, but our retirement takes priority. Once things are looking solid there, likely I’m thinking we’ll just shovel everything into a taxable for simplicity and flexibility. I’m not 100% sold on a 529’s as I’m not 100% sure what college will be like when my child is of age or if it will be the best option for them. I’m also not certain of the overall tax benefit of a UTMA vs the simplicity and ownership (in case my child isn’t ready at age 18/21/25) of a taxable account. We’ll see when the time comes how we’ll distribute their inheritance, but gifting cash for wedding or house, or gifting the taxable investments each year may be the way I’d go.
Yes, a taxable account provides more flexibility, but the other accounts do have some moderate tax advantages, at least for smaller amounts of money.
Communicating expectations is key. For us, both sets of parents are alive, and I’ve noticed two radically different approaches on inheritances and money management. One set has “stealth-wealth.” Their current will dictates a waiting period of sorts before receiving the full amount (something like “some now, the rest in several years”). This was done to encourage adult offspring to plan for future and establish a career, rather than expecting “everything.”
The other parents are somewhat financially well-off, but do not budget and always seems to stress about having enough. Without some sort of plan in place, we worry those latter years of retirement will be a strenuous time for them.
As for our personal financial plan, we are overly conservative and are planning on receiving absolutely nothing from either. This way, we will likely save more than needed, and anything received in the future will just be “extra.”
Does anyone know of actual data on life outcomes of the children of wealthy parents? Differentiating those who got a lot of financial help from those who got little? People often speak of the fear of robbing children of motivation as if this were an established fact. I think it would be difficult to measure this effect if it occurs at all.
I don’t have data specifically on this, but I do note that socioeconomic status of one’s parents is a large factor in determining an individual’s SES. Physicians, as a group, come from families with incomes and education far above the US median. These observations would seem to argue against the idea that loss of motivation is a common problem among the children of those with more than average assets.
This does seem to be the sort of thing that economists could study. They would need data on parental wealth, early indicators of childhood ability (before the motivation losing would have occurred), how much money or support the parents provided as the kids finished high school and where the children ended up financially later on. I am not sure how one could get these data. Childhood IQ tests might at least exist. I don’t know who would have systematic data about levels of financial support the kids received growing up.
I found this study
https://1gyhoq479ufd3yna29x7ubjn-wpengine.netdna-ssl.com/wp-content/uploads/FR-Born_to_win-schooled_to_lose.pdf
It suggests that, controlling for academic preparedness in kindergarten, high SES students earn more money as young adults than do low SES students. Now it is possible, but unlikely, that the high SES parents provide their kids with less financial help than do the low SES parents. Given the huge wealth gap between those groups and the just-getting-by situation in which the low SES families find themselves, it would seem almost impossible for high SES to provide less.
It is also possible that high SES help with homework and provide a home life with better educated parents but do not make any financial contributions after high school.
The stats on the financial status of those who attend the most selective colleges imply otherwise. There are a lot of students at such places who are receiving little or no financial aid. At Harvard, 30% of students get no financial aid at all. That means their families are paying all or almost all the cost, with the students perhaps contributing what they can from the kinds of jobs a college student could get.
Across all Harvard students, not just those who pay full freight, the median family income is $169,000 and 2/3 come from families in the highest quintile of income. So these kids are not covering the cost of attendance working part time in the cafeteria.
If these kids from well to do families are doing worse than most because they have been over indulged by their parents, the Harvard grads should be well under the median nationally for income, which is hardly the case.
I found the Millionaire Next Door entertaining but lacking in any kind of rigorous data collection and analysis. Maybe I should look at it again for the research I seek.
I agree, the data, while interesting, is not particularly rigorous due to the methodology.
We started making annual exclusion limit gifts to our children the years they were born. Kept it up year in and year out. We also paid for college. Our kids thus entered the working world with substantial nest eggs. They have never touched that money. They pay the income taxes on it each year and otherwise let it ride. Maybe someday it will help pay for a down payment or augment retirement funds. We hope to pay for the education for our grand kids, if we ever have any.
So our children were exactly in the demographic that was supposed to be ruined by excessively generous parents. Have not seen any evidence of this.
Beyond anecdote, I am not sure it is a real concern.
I havent read all of the prior comments – so forgive me if I am bringing something up that has been alreadly addressed…
I am wondering what the thoughts are on having UTMA / UGMA accounts for the kids, but you do not disclose the account to your kids until they are in a stable life situation and a bit older, so they dont blow it on something stupid at 18 years old? Any thoughts on this devious approach?
When they turn 18 it is their money. They have control over it and you do not. They are liable for paying the taxes on the account and signing the return. How do you manage all that without telling them about the account?
If that is what you want then don’t use this type of account. Create a trust on your child’s behalf, with yourself or someone else you trust as trustee. Give your kids control over the trust at whatever age you like.
It isn’t that devious. I established one for each kid and put any stray money (e.g., birthday and Christmas gifts) in it. I told them about it but generally they didn’t give it much thought. Yours won’t either. I never told them it was theirs at age of majority. After they graduated from college we had a long talk about acceptable uses of the money and then we transferred it to a new account. They have both been very responsible with the money.
Well, if they find out they can take the money and spend it on cocaine. But I’m not sure there is a legal obligation to tell them about it. And once they turn 18, you can’t manage it. And they have to report that income on their taxes. So it might be a real disservice to hide the existence of the account from them. A better approach in my opinion is don’t put more in there than you’re comfortable seeing spent on cocaine and use it to teach them about money and investing.
The age thing must be state dependent. In MD it is 21.
Yes, varies by state from 18-21. I think it’s 21 in UT too, but not absolutely sure.
The dilemma I have (I know, this is a good “problem” to have!!) is that my parents gift money to the grandkids (my kids), and in doing so, the 529s are already well funded, so we keep putting the gifted money in their custodial UTMAs. I am happy to have the kids accept these monetary gifts from the grandparents (I certainly never inquire or expect them, but at the same time would not refuse them either), and am happy to have their custodial accounts accumulate these gifted moneys in their Vanguard accounts. I can tell you that my parents had set up a UTMA account for me, but never really told me about it, until after I started in med school! Up until then, my father would have my taxes prepared by someone he knew and then would just approach me to “sign here” (God, this sounds like I really had a silver spoon in my mouth…geez~). I guess I turned out okay, but I think it really helped that I was a more seasoned adult, although I am not sure that I would have blown through the money had I gotten it at 18. One thing that having this UTMA account suddenly fall in my lap did for me was motivate me to learn about investing – I was freaked out by having a chunk of change suddenly fall in my lap, so I read a couple of books (about 1996) and learned for the 1st time about index funds… Anyway, the point is that my parents were able to pull off this charade with me. Also, (completely independent of any knowledge of my parent’s doings), I formerly had a financial advisor (before going rogue and turning into a true diy investor) – I believe that she is one of the really good ones for many reasons that I will not go into – but she also had the idea or plan that UTMA accounts for the kids would not have to be revealed to them until they were a little older. My kids are in grade school, so there is a long time from now to then, but I think I will see what they are like when they are in their teenage years, and all the while, will try to educate them in personal fiscal responsibility.
We have tried to do this with all of ours. Now 20-25. They are all pretty frugal. I’m pretty sure they all know about interest, loans and mortgages, time value of money, inflation, the stock market. All had in trust accounts as kids. Now all the money is theirs in discount brokerage accounts. All stocks. A bit over 100k each. They haven’t spent any of it so far. All have college funded and 3 were smart enough to go to the university that we are faculty at so tuition is pretty much free. University is highly rated so needless to say we are happy about that. Hopefully all on their way to decent jobs but I have to admit that I don’t see them starting businesses. They have life-guarded since high school so have a work ethic. DW and I frequently discuss MND when it comes to things like cars and trips and whatnot. I’m the one who actually read MND and all the other books so I tend to be the heavy. Fingers crossed.
I think you’re on the right track WCI. Your method reminds me of my own parents. They were like the “Millionaire Next Door”, having come from nothing, ran a small business together and taught us about frugality, finances, and working hard from very early on. They took us to the credit union every week as kids to deposit our allowance. I always worked since age 12, and they did the “daddy match.” When I saved up enough money for a car at 16, they gave me half of the money so I could keep saving the rest. They taught me how to contribute to a roth. These savings from my childhood and undergrad years allowed me to pay for my first two years of medical school at an in-state public school. I paid off my medical school loans two years out of fellowship, and have a net worth of $1 million 7 years out of fellowship. Their generosity has set me on a good path that I can’t thank them enough for, and yet they did it while instilling a sense of pride in hard work and saving. They are now happily retired and I try to treat them whenever I can!
Sounds like great parents and a great kid to me.
Do you divide the inheritance equally or based on need?
Very personal choice of course, but are splitting equally even if the kids end up with uneven economic outcomes in life. I suspect we would think differently with a special needs child.
Shoot, they’re 4-15 years old right now. Do I have to make that decision yet? Right now it’s all set up equally and it’ll probably stay that way, but reasonable people could disagree.
I left out the pronoun “we” as in, we are splitting… That is, I was commenting on what my wife and I are actually doing in response to Kevin Tobin’s question.
The only item on the list that I have a philosophical quibble with is the UGTM account as a vehicle for known major expenses (e.g, weddings). We figure those, or at least the first one, are on us.
Your money, your choice. We’re not really sure what we’ll be paying for in their 20s, but a wedding seems pretty likely to be on us, at least to a certain dollar amount.