"We're spending our kids' inheritance."
That was the custom license plate holder my parents (gleefully) attached to their new recreational vehicle when I was a kid. I wondered at the time if there was a broader conspiracy among adults to shaft all the kids.
But today I don't mind the fact that my parents took the opportunity to make it public that there were some things more important in their lives than my financial stockyard. After all, they earned it, not me. I haven't seen an inkling of guilt on my parents' faces either (though the RV with the vanity holder has since caught fire and burned to the ground in what could possibly be interpreted as an episode of karmic payback for their gloating).
Nevertheless, many parents today feel compelled to deny themselves things they've worked hard for in order to provide extended financial support for grown children or grandchildren. In particular, paying a child's college tuition seems to have turned into a burden that it's assumed all parents should shoulder. The intent is admirable -- to give the child a leg up in a tough world -- but in some cases, this plan could backfire.
Money well spent?
Paying educational expenses has become much more complicated than it was 20 years ago because college tuition expenses have ballooned. And parents are rightfully wary of their children racking up tens of thousands (even hundreds of thousands) of dollars in student loans.
In response, families have been utilizing a number of education savings vehicles that have been formed in recent years -- such as 529 plans and Coverdell accounts -- and planning anywhere from $100,000 to more than half a million to fully fund each child's future college expenses.
But there are two larger issues to be concerned about here:
- Circumventing the child's own education about money.
- The crippling effect this could have on one's own retirement.
Oftentimes a child who has his or her way paid, without an awareness of the work and sacrifice needed to make the paying possible, gets a distorted view of how the world works. Facing financial dilemmas themselves is often the best way for children to learn. In my case, I've found that personal experience always trumps "what Daddy says." I can tell my kids 100 times not to touch the hot barbecue. Or that shaving cream really doesn't taste good. Ultimately, though, the shock of experience is what it takes to have common sense sink in. And a mouthful of menthol foam does that better than just about anything.
The second concern about personal retirement may sound a little selfish, but some priority does need to be placed on one's own well-being. Retiring with little or no cushion for unexpected expenses or disasters is a risky plan. Obviously, every child and family situation is different, and some families may be fortunate enough to fund both educational expenses and a healthy retirement. But make sure you know the choices you're making.
Tough money love
Assuming you are not awash in piles of money, there are ways to balance both approaches. There's likely no harm in providing some level of endowment for children if you have them actively contribute to their retirement savings account and help manage it. That way they have a sense of ownership and sacrifice tied to the future benefit. It also helps them focus on what needs to be done to meet the necessities in their life -- at least something more than just calling mommy or daddy for more money to pay the credit card bill.
So if you're a parent or grandparent concerned that a direct financial endowment would not be the best economic education for a child, here are a few alternatives:
1.
Start with ShareBuilder.
ShareBuilder, a low-cost broker, allows parents to open an Education Savings Account (ESA) or a custodial account. The ESA is set up specifically for education expenses, while a custodial account lets you control the money until the child is an adult. Through these accounts, ShareBuilder lets you invest in any of thousands of stocks, or even low-expense, broad market exchange-traded funds (ETFs). Common ETFs include SPDRs (AMEX:SPY) and Nasdaq 100 Trust Shares (NASDAQ:QQQQ), which sport an ultra-low 0.10% and 0.20% expense ratio, respectively.
2.
Buy stocks directly.
Through Dividend Reinvestment Plans (or DRIPs), anyone can buy even small quantities of stock directly from thousands of companies and have the dividends automatically reinvested. Many parents open a DRIP (as a custodian for minors) in widely held companies such as AFLAC (NYSE:AFL), ExxonMobil (NYSE:XOM), or Bank of America (NYSE:BAC). These large, stable companies charge virtually no fees to purchase shares or reinvest dividends, allowing children to periodically invest small sums themselves without racking up discouraging trading costs.
3.
Use your IRA.
Education savings plans can have a number of drawbacks, so your best bet may be to simply utilize an existing IRA. The standard and Roth IRAs both have provisions to waive withdrawal penalties for qualified education expenses. This may be an ideal means to use your own retirement savings with discretion, rather than funding an education account that has more prohibitive or restrictive terms.
The Foolish bottom line
For those like me who are still wrestling with all these options, understanding the details of various savings plans and their tax implications can be daunting. Fortunately the Motley Fool Rule Your Retirement newsletter service provides the resources to help sort out which plan is best for different situations. I find the information well worth the subscription price, but you don't have to take my word for it -- you can have full access for 30 days with a free trial by simply clicking here.
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Fool contributor Dave Mock plans to spend his kids' inheritance too. He owns shares of ExxonMobil. A longtime Fool, he is also author of The Qualcomm Equation . The Fool has a disclosure policy.
