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Another Golden Oldie; How to best set up your children financially. June 17, 2009

Posted by shaferfinancial in Finance.
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This question has been proposed to me by several clients.  So I decided to spend a little time discussing this important topic for parents.

First,  is education of course.  As soon as they start understanding the concept of money, you should introduce the theory of saving.  Create a savings account for them at a early age.  When they get to an appropriate age then let them handle the details.  Games like CASH FLOW can help too.  But beyond early education there are some realities that need to be dealt with.  So I want to concentrate on strategies parents can employ to deal with the reality of young adults psychological makeup.  Now, you are always going to have some children that from an early age are financially astute.  However, these kids are the minority.  The reality is, despite being correctly raised, most will spend their teens and twenties behaving with other priorities.  Part of this is the result of the slow maturation of a human brain where neurons that are actually created in the early teens are not wholly linked up to the rest of the brain until the twenties.  Environmental influences encourage reckless behavior that coincides with this lack of a fully mature brain.

So, although education is important, it will likely not take hold until later in life for most.  Combine this with the fact that most young adults make moderate salaries, including college educated ones, and you see why the evidence points out to the age of 40 where concerns for retirement and their financial future really emerge.

So, I have developed two strategies that parents with some disposable income can employ to really give their children a great start.

But first the rules:

1.  First, make sure you have a reasonable plan for acquiring wealth in place.  The best thing you can do for your children is not be a drain on their finances during your senior days.

2.  Second, don’t listen to those “experts” who think you should fund a tax deferred investment for your kids.  This makes little sense, the amount of time young adults have to retirement will assure a huge tax bill coming due when they take the money out of the 401K/IRA/Annuity.  Since they make moderate incomes, their current taxation is not the problem.

3.  Finally,  help them in their twenties and thirties (or even earlier if you can afford it), when they are least likely to help themselves or be able to help themselves.

4.  Set up the following accounts with the thought that you want to keep them from having full access at least to age 25.  Talk to a good lawyer to help you figure out how to do this!

So here is a plan for a $12,000/year budget, but you can change the amounts for any budget:

Set up a money market or savings account for the child or young adult.  Every month put automatically a deposit of $500 into the account.  Do this for at least 10 years.

Have the adult open a brokerage account or you open one under the child’s name.  Whenever there is enough money in the savings account buy one share of Berkshire Hathaway B’s (current cost $3000).

Buy a Equity Indexed Universal Life Insurance Policy for the child.  Fund it with $500/month for at least 10 years.  Make sure to have it set up to minimize the insurance face value under IRS codes.  You will need to have a fixed amount of time you plan on making premiums to set this up right.

So let’s take a look into the future.  Let’s say you made a 15 year commitment to your child’s financial future, starting at his 20th birthday and going to he is 35 years old.  Now, Berkshire Hathaway has returned over 21% for the last 43 years and over 18% for the last 10 years, but lets be conservative and use 15% for the next 15 years.  For the EIUL I use a ultra conservative 6.5% rate of return and use the 15 year commitment.

When he is 35 years old he will have a brokerage account worth around $335,000.  His cash value  (I used a male for this example) would be $104,000 with a face value of $760,195.

Now remember this is about the age where we find adults starting to take their future finances seriously.  But let’s say he does nothing else but maintain these two accounts.  What does it look like at age 65?  Well his brokerage account is worth about $29,000,000.  Yes, that’s right.  And his insurance account is worth $711,000.  Now, remember the brokerage account number is very speculative assuming that 15% rate of return for 45 years.  But I just wanted to give some perspective to this.  I don’t really believe that Berkshire Hathaway can continue its return for 45 years, but I do believe if can for the next 15 years.

Now you might be asking why fund an insurance account when the money will create so much more wealth in Berkshire Hathaway.  Two reasons, one we don’t want any temptation to spend from that brokerage account, so we have the cash value inside the EIUL that can be accessed for things like a down payment for a home/investment property or a wedding, or a temporary job loss, etc.  Remember it can be accessed tax free.  Learning to borrow and pay back from your insurance cash value is a valuable lesson as well as a cheap way to borrow.  Secondly,  a sound financial strategy for dealing with wealth are these EIUL’s which he will already have experience with.

So there it is.  An easy way to set up your children for an abundant future.  Dial the numbers up or down as your budget allows, but stick to it for at least 10 years and your children will have a living legacy, then give away your money at death to your favorite charity!

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