MONEY Kids and Money

The Surprising Place Your Kid Should Save His Summer Earnings

Pitcher of lemonade and a money jar
Your teen's summer earnings may not seem like much now, but they can serve as a cornerstone for his retirement 50-odd years in the future. Somos/Veer—Getty Images

Get your teen started off now in a Roth IRA for a big payoff down the road, says financial planner Kevin McKinley.

A few weeks ago, I wrote about how to figure out how much money you need to become financially independent, and how the process could help you teach your kids to reach the same goal.

But talking the talk only goes so far. You can walk the walk by helping them start saving for retirement in…drumroll, please…a Roth IRA.

Why a Roth IRA?

For most younger workers, the Roth IRA is preferable to a traditional IRA for two reasons.

The first is that contributions to a Roth IRA can be withdrawn at any time for any reason with no taxes or penalties whatsoever. Therefore, that portion of the account can be taken out for other expenses, such as college or a down payment on a house, without a severe cost.

The second reason the Roth IRA rules is that younger workers typically are in a low tax bracket, and therefore don’t need the deduction that a traditional IRA provides. But once they get to retirement, all the money in the Roth can generally be withdrawn with no taxes at all.

How much your kid can save

Children of any age can open a Roth IRA account—as long as they have legitimate earned income. Flipping burgers and bagging groceries certainly counts, but so does self-employment like babysitting and yard work, especially if it’s done for someone other than you.

Just make sure to keep track of what your kid makes so you know how much can be deposited in to the Roth IRA. For 2014 the contributions to a Roth IRA are limited to the lesser of the kid’s earnings, or $5,500.

Technically, for the 2104 tax year, the money doesn’t have to be deposited until April 15, 2015, the usual deadline for the federal income tax filing.

What you can do to encourage him

Congratulations to you—and your child—if you can convince her straightaway to put her hard-earned paychecks into an account that isn’t meant to be tapped for another 50 years.

But even if you can’t immediately get your teen into the savings habit, you may be able to motivate her by using some of your own money. The money for the Roth IRA doesn’t necessarily have to come from her. She can spend her earnings, and you can deposit into the Roth on her behalf.(Just remember that your deposits then become her money, and she’s free to do with it as she pleases once she reaches adulthood.)

Also, keep in mind that the source of the deposit to your child’s Roth IRA doesn’t have to be an all-or-nothing proposition. You may want to tell your kid that you will match every dollar she contributes with one of your own.

For further motivation, try showing your child how time can turn a relatively-small amount of money into a small (or large) fortune.

For instance, let’s say you and your child deposits $5,000 into a Roth IRA when he’s 15 years old, and it grows at a hypothetical annual rate of 6% per year.

By the time he’s 65 (and it will happen sooner than he thinks), the account would be worth over $92,000.

But if he has the earnings and discipline required to set aside $5,000 in to the same account every year until he turns 65, the Roth IRA will provide him with a tax-free total of $1.6 million.

And if that doesn’t get his attention, no amount of walking and talking will.

__________

Kevin McKinley is a financial planner and owner of McKinley Money LLC, a registered investment advisor in Eau Claire, Wisconsin. He’s also the author of Make Your Kid a Millionaire. His column appears weekly.

Read more from Kevin McKinley

Four Reasons You Shouldn’t Be Saving for College Just Yet

Yes, You Can Skip a Faraway Wedding

The Simple Formula That Can Help You Achieve Financial Independence

MONEY

The Simple Formula That Can Help You Achieve Financial Independence

Man writing formulas on a chalkboard
You don't need a Ph.D. in math—or even a chalkboard—to figure out if you're on the path to financial independence. Justin Lewis—Getty Images

Your ability to retire well depends not on how much you save but on how much you spend, says financial planner Kevin McKinley.

As you’re celebrating our nation’s independence this weekend, you might want to spend some time—between your first and second hot dogs, maybe?—contemplating how well you’re doing in achieving your own financial independence.

Your ability to reach a comfortable retirement has less correlation than you might expect with how much money you earn, how much money you already have, or how you invest that money.

Instead, it depends upon how much you spend—and how much you plan to spend in the future. The more money you spend now and going forward, the more you will need to accumulate to support your lifestyle.

A simple formula can tell you not only how much you will need, but also how close you are now to getting where you want to be.

What’s your destination?

Start by looking back on the last month to see how much you’ve spent. You can do this by reviewing your checking and credit card account statements, or you could use an expense-tracking program like You Need a Budget or Mint going forward a month.

Once you have a handle on a typical month’s spending, subtract any Social Security payments you and your spouse or partner expect to receive in retirement (find estimated amounts at the Social Security website). You can also subtract any pension payments you know will be coming your way.

Then multiply the remaining amount by 200. The result is what you will need to have in savings, investments, and retirement accounts before you can retire comfortably.

Or, in a formula:

(Monthly Spending – Expected Monthly S.S./Pension) x 200 = Target Retirement

So, if you’re spending $4,000 per month and can expect $1,500 per month in Social Security retirement benefits, your net required liquid assets are $2,500 x 200, or $500,000.

Are you on track?

You can use a similar variation of this formula to see how you’re doing toward your goal. Again, start with your typical monthly expense amount. Here’s where you should be…

In your 20s: Current Monthly Spending x 10

In your 30s: Current Monthly Spending x 25

In your 40s: Current Monthly Spending x 50

In your 50s: Current Monthly Spending x 100

(By the way, in case you plan on winning the lottery well before retirement age and want to be financially free forever, you’d better hope you hit the Mega Millions, since you’ll need about 300 times your monthly expenses.)

If your net worth isn’t where it should be, don’t panic. Instead, go back to your list of expenses to see what is less important to you than your long-term financial security, and try to reduce or eliminate it. A quick way to increase your net worth and reduce your spending is to bump up your deferral in to a pre-tax retirement plan, like an IRA, 401k, or 403b. The money is still yours, but since you’re taking home less, you’ll be forced to live on a little less (and you can always change it back).

Bonus: Saving more for retirement this way also means you’ll pay less in taxes each year.

Will your kids be on track?

Best of all, this process can help you provide a priceless lesson to your children.

Many of us want our children to have high-paying jobs in adulthood so that they can cover their own living expenses with as little parental assistance as possible.

But simply by learning that it’s easier to spend less money than it is to make more, our children will be free to pick an occupation based on what they find most fulfilling, rather than the one that just fills up their bank accounts fastest. Minimizing their expenditures also gives them more flexibility to change careers, move to a more desirable location, go back to school, or stay home to care for a child (our grandchildren!).

Most importantly, spending less money allows them to save more of what they earn—so that they’ll be able to reach their own financial independence much more quickly.

__________

Kevin McKinley is a financial planner and owner of McKinley Money LLC, a registered investment advisor in Eau Claire, Wisconsin. He’s also the author of Make Your Kid a Millionaire. His column appears weekly.

Read more from Kevin McKinley:

Four Reasons You Shouldn’t Be Saving for College Just Yet

Yes, You Can Skip a Faraway Wedding

This is What Sting Should Have Done for His Kids

MONEY Kids and Money

This is What Sting Should Have Done for His Kids

140623_FF_Sting_Sting
Musician Sting performs during the 44th Annual Songwriters Hall of Fame ceremony in New York June 13, 2013. Carlo Allegri—Reuters

Financial Planner Kevin McKinley argues that there are ways to give your children money without having to worry about them becoming trust-fund brats.

Recently rock legend Sting made headlines when he declared that his six children would be receiving little to none of his estimated $300 million fortune.

He joked that he intended to spend all of his money before he died. But on a more serious note, he explained that he wanted his kids to develop a work ethic, and not let the wealth become “albatrosses around their necks.”

His motives are admirable, and he’s certainly within his rights to use his money however he pleases. But as a financial planner and a dad, I’d argue that there is a lot of room between over-indulgence and complete denial. And in fact, used the right way, your wealth can help motivate your child.

Here are three ways you can sensibly use a relatively small amount of your own money—during your lifetime—to encourage your kid’s productivity and self-reliance, without spoiling him rotten.

1. Save something for his college

You don’t need to put every dollar you have in to a college savings account, nor do you need to pay the full cost of some high-priced private school.

But setting a little aside sets an example of your commitment to your child’s education. It also can ensure that she doesn’t have to choose between taking on a six-figure debt load, and not going to college at all.

Let’s say the parents of a recent high school graduate started saving just $50 per month at her birth, and it returned a 6% hypothetical annual rate. By now they would have over $19,000—enough to pay tuition, room, and board for a year at a typical in-state four-year university, according to the College Board.

The remaining years can then be paid for by some combination of parent earnings, a relatively manageable amount of student loans, and the student’s part-time job.

2. Jumpstart retirement savings

Speaking of jobs, once your kid earns his first paycheck you have another chance to use a little money to teach a valuable lesson.

Open a Roth IRA on his behalf by April 15th of the year after he gets his first job. He’s eligible to deposit the lesser of his earnings, or $5,500.

Kudos to you if you can get him to contribute his own money. But if you can’t get a teenager to understand the importance of retirement—I mean, let’s be realistic—you can instead make the contribution out of your own pocket. Or offer to match an amount he puts in, which you can explain to him is the easiest way to double his money. (This is also a good way to set up his understanding of an employer retirement match down the road.)

One way or the other, saving a little now could mean a lot down the road. A $5,000 deposit today into a 16 year-old’s Roth IRA earning the aforementioned 6% annually would be worth almost $100,000 by the time he turns 66.

And if the initial gesture inspires him to deposit $5,000 of his own money into the Roth IRA every year for those fifty years, the account could be worth a cool $1.5 million by the time he hits 66.

3. Help with the house

Hopefully your child eventually becomes an adult in both age and responsibility. That might be the time she wants to buy her first home.

The National Association of Realtors says the median home price in the U.S. as of May of 2014 is about $214,000.

If your child’s (and/or her spouse’s) annual income totals around $60,000, she should be able to qualify for a 30-year 4% mortgage to purchase a home in that price range, leaving her with a monthly mortgage payment of about $1,300. But she may still need to overcome the biggest obstacle to the purchase of a first home: the down payment.

Even the savviest young adult might have a hard time saving up the $42,000 needed to make a 20% down payment on that average purchase price.

Helping her meet that down payment requirement will not only get her the satisfaction of home ownership, but it will help her build equity in something with her own money. And it might mean you have a place to stay if, like Sting, you end up spending all of your money before your time is up.

__________

Kevin McKinley is a financial planner and owner of McKinley Money LLC, a registered investment advisor in Eau Claire, Wisconsin. He’s also the author of Make Your Kid a Millionaire. His column appears weekly.

Read more from Kevin McKinley

Four Reasons You Shouldn’t Be Saving for College Just Yet

Yes, You Can Skip a Faraway Wedding

MONEY Budgeting

Yes, It’s Okay to Skip a Faraway Wedding

Kim Kardashian and Kanye West wedding
Jay Z and Beyonce turned down an invitation to Kim Kardashian and Kanye West's wedding in Florence. So what's stopping you from saying no to your cousin's big day in Boise? via Twitter

For families, the costs of attending weddings add up fast. Financial planner Kevin McKinley offers a few ways to keep expenses in check, including just saying "no."

The average American will spend $109 per wedding gift given this year, according to a recent survey by American Express.

But that sum is a mere fraction of what is spent to attend a wedding. The same survey says that guests will fork over, on average, an additional $592 per wedding per person on transportation, lodging, and the like. That’s significant enough if you’re a single person, but for families with young kids, the costs can really put pressure on the household budget. For a family of four, you’re looking at around $2,400 based on the AmEx survey, and that’s just average. When your cousin decides to get married in Martinique or your best friend from college picks the Ritz as the hotel of choice, your bill could easily be double that.

And for that pricey amount, you’ll likely end up spending more time shushing and soothing your kids than you will be partying it up with the wedding couple and their other guests.

Here are some better ways families can honor a bride and groom getting married at a distance, without breaking the bank or damaging your relationships.

•Decline but pump up your gift. Of course, the cheapest option is to say no to the invitation. To avoid any hurt feelings or questions, include a personal note that expresses your best wishes and your regret over not being able to make it–you might allude to the difficulty of choosing between bringing the whole family along and finding a suitable sitter for several days of round-the-clock care. Now to really take the sting out of the decline, consider sending a gift of cash that significantly exceeds the average gift amount (assuming you can afford it).

Don’t worry about offending the couple—55% of couples in the American Express survey said that they prefer cash to other more tangible gifts.

Even though you’re spending more than you usually would on a gift, you can think of it as savings over what you would have spent on the trip. That gift will go farther for the recipients too, since you’ll also be saving the couple (or their parents) the $220 per guest a survey from TheKnot.com found to be the average amount spent on food and entertainment at weddings in 2013.

What it’ll cost you: $300, assuming you give a gift triple the average amount.

•Decline, but make a date to celebrate separately. The other downside of spending thousands of dollars to attend a wedding—besides spending thousands of dollars—is that the bride or groom won’t be able to give you more than a few minutes of their attention. And if you don’t know anyone who will be attending besides the bride and groom, you’ve spent about $1,000 per minute with your friends.

You can get more quality time for less cash by getting together separately with the newlyweds after the wedding. So, if they live near you but are having a destination wedding, schedule a date to take them out for dinner when they’re back. If they live elsewhere, make a plan to visit them in their town, with your kids, at a different time. You’ll be able to pick your dates according to the most affordable time to travel, and perhaps save on hotel and dining costs by staying with the couple.

What it’ll cost you: $550, assuming you give a generous $200 gift, take them out for a $300 meal, and pay a babysitter around $50 to watch your kids; what it will cost to visit at another time depends upon where they live, whether you fly or drive, whether you stay with them and how much you spend on the gift

•Leave the kids at home. If you must attend the wedding, whether due to a sense of obligation or anticipation, you might consider leaving the children at home with a sitter or trusted relative. The net cost of the trip will still be much less than if you brought the kids, and you’ll be able to relax a little and enjoy yourself more.

What it’ll cost you: $1,184 based on the per person numbers from American Express and assuming you can convince a family member to babysit for free; more if you can’t.

•Fly solo. Can’t find someone to watch the kids but still want to go to the wedding? Another more affordable route would be to have the parent who’s less familiar with the couple stay at home while the other attends.

What it’ll cost you: $592 based on the per person numbers from American Express, plus the cost of a very nice souvenir for the parent who didn’t get to stay in a hotel room and wake up late!

•Make a vacation out of it. You’re probably planning some kind of family getaway anyway. And hopefully you’ve already set some money aside for this purpose. So look for ways to build your trip around the event so that your money does double duty (most importantly because you avoid paying for pricey airfares twice).

Could you tack on a week before or after the celebration? Is there someplace you’d all like to go that’s within driving distance? Turning the event into a vacation can make it more fun for all involved.

What it’ll cost you: More than $2,400 probably, but you’ll still save money by combining two trips.

______

Kevin McKinley is a financial planner and owner of McKinley Money LLC, a registered investment advisor in Eau Claire, Wisc. He’s also the author of Make Your Kid a Millionaire. His column appears weekly.

MONEY Kids and Money

Four Reasons You Shouldn’t Be Saving for College Just Yet

158313476
KidStock—Blend Images/Getty Images

You should make these moves before you start funneling away money for tuition, says financial planner Kevin McKinley.

As graduation ceremony season nears its peak, I’m seeing a steady drumbeat of stories warning of ever-rising tuition costs and education debt loads. It’s no wonder many parents of smaller children are panicked into thinking they have to drop everything and start saving all their money for their kids’ college expenses RIGHT NOW. Hang on just a second there, moms and dads. Although I’m certainly in favor of getting parents to save, there are four things I’d suggest you should do—and one you shouldn’t—before making “saving for college” the top priority. (Already completed all of these steps? Check out the MONEY 101 section on college for help getting started on your college savings journey.) DO save for retirement Since it’s possible to borrow money to pay for college but not to fund retirement, working parents have to put their own needs first. You should start by putting money in any pre-tax retirement savings plans at work (such as a 401k or 403b), at least up to any available matching contributions from employers. If no employer-sponsored plan is available, those with earned income should fully fund an IRA. You may be able to make a deposit for a stay-at-home spouse, as well. You can save up to $5,500 in 2014, or $6,500 if you’re 55 or older. The tax savings on the contributions to a pre-tax retirement plan will likely exceed what the deposits to a college savings account are likely to earn, especially in the first year. Then if you end up with a well-funded retirement, you can tap their overstuffed accounts once you hit 59 1/2—and have passed the penalty zone—to pay for college expenses as needed or pay off student debt incurred by your children. DO open a Roth IRA For eligible depositors, Roth IRAs can serve as a hybrid college/retirement savings account. These accounts—which allow for tax-free withdrawals—are typically thought of as a retirement savings vehicle. But if parents want or need the money before retirement for college (or other) costs, they can withdraw the Roth IRA contributions at any time for any reason with no taxes or penalties whatsoever. As an added bonus, money held in parents’ retirement accounts is less likely to be counted in a school’s need-based financial aid calculation than funds in the child’s name. DO pay off credit cards Double-digit interest rates charged on outstanding balances—the average APR is now around 16%—usually greatly exceed what you’d earn on your money elsewhere. So you’re better off erasing your debt before putting a lot of attention toward college. Plus, an improved credit score will make it easier for you to obtain higher education loans for your kids should the need arises in the future. DO prepare for the worst The majority of parents of younger children haven’t established wills, guardians, and other necessary legal steps—much less purchased enough life insurance to ensure that the tragic death of a parent will only be an emotional nightmare, and not a financial disaster as well. Moms and dads should see lawyer as soon as possible, and plan on spending a few hundred to a few thousand dollars, depending on the complexity of the situation. You should then purchase enough term life insurance to cover all future expenses—including college—that the survivors might endure. DON’T pre-pay the mortgage Well-meaning parents often try to pay down their housing debt as quickly as possible, thereby saving interest expenses and freeing up money that would otherwise go toward the monthly mortgage payment. But that step should only be considered if the parents are ahead of their retirement savings schedule, have no other debt outstanding, no future major expenses on the horizon, and have at least a year’s worth of living expenses saved up. Those parents who don’t meet these criteria should stop paying anything extra on their mortgage until they have fulfilled the other aforementioned financial obligations. Otherwise, parents could end up house-rich and cash-poor—just when it’s time to pay for their kids’ college expenses and their own retirement. _____________________________________________________ Kevin McKinley is a financial planner and owner of McKinley Money LLC, a registered investment advisor in Eau Claire, Wisconsin. He’s also the author of Make Your Kid a Millionaire. His column appears weekly.

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