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Kids may not have the knowledge or capacity to invest. But you do!

Whether you’re a parent, grandparent, uncle, aunt, or have some other relation to a child, you can change their financial life with a simple and consistent strategy. From the moment of a child’s birth, you can harness the power of compound interest.

With discipline, the opportunity for leaving a legacy throughout the generations is enormous.

Here’s how the magic works.

Saving for Minors

Did you know that you can massively affect your children’s financial future with small steps today?

Consider what would happen if you saved $100 per month for your child beginning at birth. Since we’re planning for the very long term, they could easily withstand the volatility of an aggressive all-equity strategy.

If you save and invest $100/month for the first 20 years of their life at an estimated 9% average rate of return, their account could have grown to around $65,000 by their age of 20.

Let’s say they save no more for the rest of their working career, but simply leave that $65,000 invested. If they earn an average of 9% from age 20 until 65, their account would have accumulated to more than $2 million!

And that’s without them contributing a single dime to retirement! Imagine the possibilities if they added their own contributions as well.

How Much Is Enough?

That $2 million figure sounds great, but how much is really enough to provide for retirement when we’re talking about 65 years into the future? After all, inflation is all too real!

The Bureau of Labor Statistics found in 2022 that the average US household spent just over $6,000 per month. This included mortgage payments, though, and any other forms of debt servicing. In retirement, if the individual has planned ahead, hopefully he or she will be debt-free.

But let’s be conservative and say $6,000 per month is the goal. At an inflation rate of 2.5% annually (just above the Fed’s target), we’re looking at about $30,000 per month in 65 years for the same purchasing power. That’s an annual income needed of $360,000!

Sounds outrageous, right?

But consider this: according to the United States Census Bureau, the median household income in 1960 was $5,600 per year. Inflation happens!

So let’s assume the following:

• $360,000/year expenses starting 65 years from now
• Inflation is ongoing at 2.5%
• Retirement time horizon lasts from age 65 until 90
• Average annual return on investment is 7% after age 65
• We’ll leave Social Security out of the equation for now

Under these circumstances, the child born today would need a retirement account of about $5.5 million by age 65 to last them until around age 90.

Remember, though, that there are several factors which could make this required number lower:

• Social Security payments are extremely likely to be available, albeit not as generous as today’s figures.
• The Fed might meet their target inflation rate and average only 2% annually.
• The retiree may have lower monthly expenses due to paying off all debt.

Let’s go back to the original equation of saving $100/month from the child’s birth to age 20. Under the assumptions we used previously, they reached $2 million by age 65.

If the goal is to fully fund the child’s future retirement, then we might be more inclined to save $3,200/year, or $267/month, for the first 20 years of their life.

Though we’re well below the maximum allowed gift in these figures, it’s important to keep this in mind especially if you plan to gift a lump sum up front. The max allowable gift in a year as of 2024 is $18,000 from each individual to each individual. In other words, you could give $18,000 per person to three children for a max of $54,000 given away that year. If you’re married, your spouse could do the same thing to essentially double the gift.

Whatever the amount you decide to save, if any, this is an incredibly powerful way to leverage time and to set a child’s future up for life.

Just think what someone could do if they didn’t even have to think about saving for retirement. Or more realistically, imagine what they could do if they only had to contribute a little extra toward retirement rather than making that their primary goal. The excess cash flow they could generate might go toward building a business, funding charitable missions or simply providing a higher standard of living for their own family!

Which Account Type Is Available?

Whether it’s $25 a month or $300, maybe you’re ready to start investing in your child’s future. But where should you start?

The first thing to do is to open one of the following:

• Uniform Gift to Minors Act (UGMA)
• Uniform Transfer to Minors Act (UTMA)

If you plan to include physical assets in your gift, then the UTMA is better suited to that purpose. If you simply plan to gift financial assets, then the UGMA is sufficient.

These are taxable accounts, but the child cannot start saving into a tax-free retirement account (Roth IRA) until they have some sort of earned income. As soon as they begin earning an income, you can fund a Roth IRA up to the lesser of their earned income or the max allowable contribution.

Until then, the taxable account of an UTMA or UGMA can be used.

When the child reaches the age of majority (which varies by state between 18 and 21), the money becomes theirs. Because they can use the money for any purpose they choose, it is important to make it clear what your intentions have been behind the use of the money. If it is for retirement, then they can begin to gradually move that money into a retirement account as they begin earning an income.

As of 2024, the max allowable 401(k) contribution is $23,000 per year for those younger than 50. The max allowable IRA (or Roth IRA) contribution is $7,000.

Assuming they make at least that amount in earned income ($30,000), and they don’t make too much income that phases them out of their eligibility, then they can do the following:

• Contribute $7,000 to their IRA or Roth IRA.
• Establish an automatic payroll deduction from their paycheck to fully fund $23,000/year to their 401(k) or Roth 401(k).
• Withdraw $23,000 from their UGMA or UTMA to make up the difference for living expenses. Remember that capital gains will be taxable.

With this strategy, they can typically move the majority of the account into retirement accounts within just a few years. Then the rest is history. It remains invested for retirement.

Conclusion

There are so many expenses that come at young adults: higher education, wedding, car, house.

Usually retirement is not the first thing on their minds.

But you have the opportunity to make that difference in their lives. By consistently saving from an early age in the child’s life, you can give them a gift that simplifies their entire financial future.

In my opinion, saving for higher education like college is of number one importance to a child. They have an entire career ahead of them to save for retirement, and little ability to save for college during their childhood or young adult years. But if you have capacity to go above and beyond, this strategy of extra savings can work wonders.

Of course, we don’t want to hand everything to our kids on a silver platter. It’s important for them to forge their own path and shoulder responsibility. But leaving a legacy is about finding that balance and instilling values in our kids so they can stand on our shoulders to go further than we did.

Investing in them from day one can mark the beginning of that journey.