Financial Tips for Your Adult Children
How to teach your children to become financially responsible adults
As they get older, you want your kids to thrive on their own earnings, while building toward major expenses like a home purchase, raising their own children and retirement. How do you help them get there?
There are plenty of things you can do when they’re young. And there are a few key inflection points thereafter – when they leave for college, when they start in the workforce full-time, and when they start to think about long-term financial goals. Here are some concepts to teach them as they near and enter adulthood.
Teen to College Years: Budgeting, Borrowing and Credit Score
As a teen, your child should have their own money – whether from an allowance, a part-time job, or doing chores around the house. Let them spend their money how they choose. A few mistakes here and there won’t be a big deal, but will be very instructive: Spent too much on fast food to afford concert tickets? Tough luck! Don’t bail your kids out for a mistake like that.
As your kids consider college, introduce higher level concepts, such as borrowing. Most teens (or parents) will need a loan to afford college. Talk through the trade-offs – is it worth paying more to go to a higher-ranked institution? How would your child’s budget as a twenty-something be affected by a large monthly loan payment? Discuss the current student debt crisis and steps your child can take to avoid being affected.
Also talk about the importance of good credit. Taking on debt and paying it back responsibly allows them to take on more debt, at a better rate, going forward. Consider getting your teen a credit card at age 18 with a low credit limit, where they’re the primary account holder. Since the length of the account is a factor in credit score, they’ll have a better score at an earlier age than many of their peers, provided they pay back their balance in full each month.
Or, if they’re just paying the minimum on their credit card, they’ll quickly see how debt racks up, and they’ll have time to correct course. Flexing this muscle now will help your child later, when they look at car loans, mortgages – or even as they start to look for better, perk-based credit cards, once they start working life. (Though, be careful – if your teen is added to your credit card, that will affect your credit score as well.)
Once in college, your teen’s budgeting chops will truly be put to the test. For the first time, they’ll be on their own and their time will be unstructured. How do they manage it, how will they spend? Let them find their way, while providing encouragement and guidance along the way – but resist the urge to swoop in and take care of their financial jams. Make clear that you’re available to support them – not to be their ATM.
Working Life: Taxes, Insurance and Rainy Day Funds
The working world may come as a culture shock to your child. No institutional or parental structure means your child will be managing every financial decision, from where to live, to how to grocery shop, to what’s worth saving for. This can be a lot. Expect some bumpiness.
A few key things may initially be overlooked or ignored. For example, many people don’t do their own taxes until they’re in their 20s. As a result, there are some holes in their knowledge.
- Taxes: Take advantage of exempt income opportunities. A transit benefit account and a Health Savings Account are two examples of this. In each instance, your child’s take-home pay will be lower, but the actual money they have available to spend will be higher, provided they need transit funds and money for healthcare. Help them do the math to see this. (We’ll cover 401ks and retirement savings below.)
- Taxes: Select the proper withholding amount. Ideally, when your child files in April, they don’t want to make a large payment. As your child’s income and dependents change, so will their withholding amount.
- Taxes: What kind of employee are they? Independent contractors, freelancers, or other situations where your child fills out a W-9 may result in a hefty year-end tax bill, if your child isn’t prepared. Typically, they’ll need to make payments quarterly. Put your child in touch with someone who can guide them on best strategies, including taking deductions on work expenses.
Insurance is another area that twenty-somethings may not consider:
- Your health insurance plan might be the right choice. If you, as a parent, are on a good plan, it may make sense for your child to stay on yours as long as they’re eligible, typically until age 26. This especially makes sense if you’re on a family plan, where adding or subtracting one individual doesn’t cost you more. But not every family fits that situation.
- Health insurance options are tricky. When your child is deciding on their own healthcare plan, encourage them to do the math for both high deductible healthcare plans (HDHP) and traditional plans, as well as for situations where they need a lot of care and situations where they only need a little. They may be surprised. For example, HDHPs include the possibility of an expensive doctor’s visit, but, overall, they may also save your child money. Also, both types of plans have tax-advantaged accounts associated with them: a Flexible Spending Account (FSA) for traditional plans (which does not roll over year-to-year) and a Health Savings Account (HSA) for a HDHP (which does roll over year-to-year). Factor those possible tax savings into the overall cost of each. Making the right health insurance decision is time-consuming, but it can save your child money, and give them peace of mind.
- Don’t forget renter’s insurance. While often overlooked, it’s a very inexpensive way for your child to protect their belongings, give them some liability coverage, and gain access to funds for a place to stay, in case a disaster strikes their apartment.
Emergency savings are another resource that twenty-somethings aren’t known for endorsing. But for anyone looking to gain financial independence, having them is crucial.
- Rainy day funds greatly reduce stress. This will help your child engage with money problems with confidence and calmness. If an emergency strikes, such as a job loss, a major medical expense, or an expensive car repair, having the funds at the ready makes all the difference. As a parent, you don’t want to cover it for them, nor do you want them taking on debt, or dipping into retirement savings. Experts recommend 6 months of expenses saved in a dedicated account.
- Earn a return on rainy day funds. After years of historically low interest rates, it’s easy to forget that there are savings options that offer liquidity and a competitive return. Encourage your child to rate shop, so they can maximize their return.
Planning for Milestones: Major Expenses, Retirement and Time Horizons
This is the last level of financial acumen: preparing for the future with a measured, effective plan that includes saving and investing toward a variety of goals.
- Retirement saving should start early. Investments compound over time. A thought exercise: Assume an investment portfolio grows at an average of 7% a year and that all gains and dividends will be rolled back into the portfolio. How much difference could it make if your child starts investing at age 25, versus age 45? A lot. $10,000 growing this way for 40 years turns into $139,744.58. That same $10,000 growing for 20 years turns into only $28,696.84. That’s a big, big difference!
- Put at least some money in a 401k. Even if starting out at a low salary, your child should contribute enough in their 401k to capture their employer match. This is basically a gift, if they choose to accept it, plus it gets them contributing a little themselves. Beyond that, funding retirement savings to the max ($22,500/year in 2023) may not be feasible in the beginning. If your child has a low salary, student debt, or lives in an expensive housing market, they should put in as much as they can without impinging on their other responsibilities.
- Most retirement savings reduce your tax burden. Whether through a 401k at work, or a traditional IRA, retirement savings can be deducted from taxable income. In turn, this reduces your child’s overall tax burden that year – and saves them money. The money grows tax-free and then is only taxed as income when your child retires and pulls it out. One exception to this is a Roth IRA. The money contributed there cannot be deducted from taxable income, so it’s taxed up front. However, once it’s in a Roth, the money grows tax-free and it will eventually be withdrawn tax-free. Especially if your child is in a lower tax bracket at the start, this could make a lot of sense.
- 401ks are not the only retirement savings vehicle. 401ks are plug-and-play through your child’s employer, making them easy to use. But, there are other options, like a Roth IRA or a traditional IRA. Or, if your child doesn’t have a salaried job, they may need to open their own IRA. There are a variety of options, some designed specifically for freelancers – have your child talk with an accountant about these.
- Managing a portfolio takes time and experience. If your child is excited about trading regularly (a few times a week) within their portfolio, caution them. Timing the market is notoriously challenging. Plus, investing is about a lot more than just picking the right stocks. Layered goals require layered strategies. For example, saving for a down payment on a home is very different than saving for retirement. While that may seem obvious to you, it’s not necessarily obvious to your child. As your child’s needs, expenses and assets evolve, encourage them to consult with a wealth management professional.
- Choose an advisor carefully. Ideally, your child’s finances will eventually get large enough that they’ll want an investment or wealth advisor. Selecting the right one is crucial. Your child should find an advisor who listens and designs customized plans that help them achieve their goals. Make sure the advisor is a fiduciary – meaning they’re legally and ethically bound to put their clients’ interests above their own – and that they are certified in their field of expertise.
Parents: Keep Your Eyes on the Objective
Everyone wants to see their children succeed. As a parent, it can be hard to strike a balance between stepping in to save the day – and letting your kids learn organically through mistakes. But, navigating toward financial success can take time and some tough lessons.
As your children mature, don’t forget the goal: allowing your kids to become fully functioning, happy adults. With patience, love and time, you can give your kids the tools to develop their emotional and intellectual skills toward money. But, you have to let them do it. In the end, you’ll be rewarded with financially independent, confident adult children.