The Gen X dilemma (part 1): how do you financially prepare and launch your children?

Gen Xers are caught in quite the pickle. You’re sandwiched between your aging parents and restless teenagers, and feel the financial pressure from both sides. You want to help, but feel uncertain of where to start. So what do you do?

In this article, we’re going to focus on how to prepare and launch your children. More specifically, we’ll zero in on how you can help them find their financial footing in adulthood. By asking the right questions ahead of time, you can set them up for success and feel the pressure of uncertainty relax.  

1) When do my kids need to start filing taxes?

Generally speaking, your adult children or legally working minors will need to file California state taxes. Even if they’re earning minimal income. But at the federal-level, things are a bit different. They’ll only need to worry about filing if their income exceeds a certain amount ($12,950 in 2022). But in either case, if they had taxes withheld, it’s best to file for the potential tax refund. 

Your children are also subject to taxes on unearned income. That’s income brought in outside regular work (ex: investments, capital gains, interest, and dividends). Various rules apply, but if your child’s income is exclusively unearned income and exceeds $1,150 (in 2022), plan on them needing to file. 

The first $1,150 of their unearned income is not taxed. However, the next $1,150 is taxed, but at the child’s tax rate (which may be 0%). Income that exceeds $2,300 is taxed at the parents’ marginal tax rate, which is known as the “kiddie tax.”

Things get a bit trickier when your kids have both earned and unearned income. If the combination of the two exceeds $1,150, and at least $350 of it was paid in unearned income (i.e. interest, dividends, capital gains), your child must file a return. 

2) Can my child contribute to a Custodial Roth IRA?

Custodial Roth IRAs are essentially retirement accounts for minors. To be eligible your child needs to earn income and pay Medicare taxes. 

But children can’t open an account themselves. They’ll need an adult to set it up and serve as its custodian to manage the assets.1 After that, post-tax contributions can be made up to the yearly maximum ($6,000 in 2022) or your child’s total taxable income (whichever is less).1

Once they reach the age of majority (that’s 18 in California), the custodial account will automatically convert to a regular Roth IRA that’s in their name. But before then, the custodial option allows your kids to hit the ground running, and learn the value of delayed gratification and compound interest.1

3) What if I overfund my child’s 529 plan?

A 529 plan can be a great way to prepare for the cost of your child’s education. But there can be repercussions if you over prepare, or rather overfund the account. This tends to happen if your child goes to a less expensive institution, pursues a different path, or has super responsible parents… 

So it’s not all bad!

But nevertheless, any withdrawals used for non-qualified education expenses face tax consequences. Your 529’s earnings will be taxed, and subject to a 10% penalty.7 But your principal amounts won’t be affected. That’s because they were contributed with after-tax dollars.2  

Also, keep in mind two important 529 rules. You can give the money to another child, and there’s no deadline to make withdrawals. There’s still plenty of tax-free ways to use leftover funds. These include, but aren’t limited to higher learning (ex: graduate degrees), K-12 tuition for the grandkids, or even paying off $10,000 of student debt per child and each of their siblings.3 You can even fund your own education if you’re looking to pivot. 

TIP: If your child earns a scholarship, there are still many ways to use the 529 funds. 

4) What important paperwork do they need when they’re 18?

Turning 18 is a big deal. With it comes the legal recognition of adulthood, and a slew of important paperwork. So if your child is nearing the big one-eight, or has already passed it, you’ll want to make sure the following documents are cleared:4

• HIPPA Authorization: By having a signed Health Insurance Portability and Accountability Act (HIPPA), you’ll be given authorization from your adult child to request and receive information from doctors regarding their health status and medical treatment.
• Durable Power of Attorney: With this, your child authorizes you to act on their behalf in critical moments. You’ll be allowed to make legal and financial decisions in the event they’re not available (ex: traveling internationally) or are unable to do so if they’re incapacitated.
• Durable Power of Attorney for Healthcare: Here, your adult child appoints you to specifically make health-related decisions on their behalf should they become incapacitated. If this isn’t in place, you’ll have to go through court proceedings to have a guardian appointed. And keep in mind they may not choose you!
• Advanced Healthcare Directive (Living Will): In this document your adult child indicates their health care preferences in advance. This can detail wishes regarding, but not limited to religious objections to treatments, organ donation, and life support measures.
• FERPA Release: The Family Educational Rights and Privacy Act (FERPA) is a law enacted to offer parents privacy regarding their children’s educational information. But once they’re 18, you’ll need them to sign a FERPA release form to have unrestricted access to this personal information. Even if you’re paying their tuition, it doesn’t mean you’ll have access to their grades. You’ll still need a FERPA release.

5) How can I help out with a down payment?

Maybe you’re looking to help your children stay in the Bay Area. If so, helping out with a down payment is huge. And there are three great ways we recommend doing so:

• Provide the down payment: You can provide the down payment to your kids yourself. Then you can forgive up to the gift limit each year until the full amount of the loan (plus interest) is forgiven.  There are specific IRS rules about how to set this transaction up legitimately, so please consult an advisor before you give your child the funds.
• Let them stay and save: You might be open to having a full nest a bit longer. If so, your children can stay with you and save up for their own down payment.
• Expand your living space: Adding an addition to your own home can pay in multiple ways. Children can stay with you, but with their own space. And once they’re gone, the addition can be rented out.

There’s also the option of co-signing your child’s mortgage. But usually, it’s not one we’d recommend. The loan remains on your credit report and can affect your ability to borrow in the future. Even if payments are made on time, the amount borrowed lingers as debt. 

6) How can I improve my child’s financial literacy?

It’s unfortunate how often personal finance isn’t a part of a school’s curriculum. Unless you’ve taken the time to teach them yourself, your kids could be saving and spending blindly. And that won’t work in a world where living within your means and preparing for the future are vital. 

But thankfully, living in the digital age has its perks. One of which comes in the form of instant access to financial resources. Here a few we recommend to have your children become super savers and savvy spenders: 

• GoHenry: Over at GoHenry, there’s a focus on getting kids in the right habits. Their debit cards can be limited to transactions pre-approved by parents. And their app enables allowances to be paid automatically, chores to be tracked, and all spending to be categorized.
• Greenlight: The folks at Greenlight have developed something similar. They’ve created an app and card of their own that empowers parents to educate, monitor, and influence their children when it comes to their finances. It’s particularly helpful for giving teens independence:  an easy request button lets your child ask for funds while they’re out.
• Acorns: Apps like Acorns make the small things powerful. If your child is 18+ they can start investing their spare change. The app offers easy-to-understand mutual funds and rounds up debit card transactions to make leveraging compound interest easy automatic.

7) Should I hire my kids into my business?

If the business is solely owned by you (or with your spouse), your children can work for you even if they’re minors. And this can be beneficial for the both of you. Here are some major upsides to hiring your kids:

• Tax breaks: The IRS encourages businesses to hire family. You’ll get a break by not having to pay FICA (that’s Medicare or Social Security) taxes.5
• Untaxed earnings: In 2022, your child can earn up to $12,950 a year in earned income and not owe taxes. After that they’ll be subject to the tax rates seen here.5 Note: if they have unearned income from investments, the $12,950 threshold is much lower (See Question #1 in this article).
• Learning the business: If your children show interest in the family business, hiring them gives them an inside look at what it takes. More importantly, it instills in them a work ethic they can carry anywhere they go professionally.

The work of course has to be appropriate to your child’s age and level of skill. Additionally, you can’t skip any of the necessary paperwork (ex: W4 and I-9) when bringing them on board. The IRS is well aware of family tax breaks, and keeps an eye out for exploitations. 

How The Advisory Group can continue to help

We partner with our clients for the long haul. We’re here to provide financial advice through economic cycles as well as life ones. And this includes the transitionary period of preparing to launch your children so they can leave the nest. 

We understand that this can be a tumultuous period both emotionally and financially for you and your family. But we’re here to help. We can guide you on the strategies, investments, and necessary paperwork to keep your children financially sound. And we can share the best strategies we’ve learned from launching our own children and helping many clients do the same.  

If you’re suffering from must-do-it-all-myself syndrome, we’ve got the cure. Our team of experts is here to work right alongside you, and make sure you and your kids are pointed in the right direction. You can get started by setting up your complimentary consultation, or calling us directly at (415) 977-1200.