Helping Adult Children Financially: Part 6 - Other Ways to Help

So far, in parts 1-5, we’ve covered many ways to help an adult child financially. In this post, we’ll cover several additional subjects, including:

• Investment Accounts
• Life Insurance and Annuities
• Real Estate
• Starting a Business

Investment Accounts

Consider the old proverb, “If you give someone a fish, you feed them for a day. If you teach someone to fish, you feed them for a lifetime.” This can be applied to parents who don’t want to simply hand over money to their adult children. Instead, they teach their offspring how to invest wisely, empowering them to increase their wealth over the long term.

Here are some classic investment pointers parents can pass along:

• Think Long Term – Sometimes, it’s difficult for young people to envision far-off future events like retirement. Add to this the fact that many in their early adult years have limited funds for savings and investments. Therefore, there is little motivation to set aside funds for such far-off circumstances. This is a mindset that young people should avoid. Having a long-term perspective will provide a rationale for deferring some gratification today to achieve a better future.
  
  
• Start Early – Closely tied to the concept of long-term vision is the benefit of starting early in life on saving and investing. The sooner one accumulates funds, the greater the chance of reaching future financial goals. For instance, the “magic” of compound interest is that savings increase faster because interest is paid today on both the initial savings amount and interest previously paid. The longer this magic is in action, the more money accumulates.
  
  
• Create a Financial Plan – Dutifully saving and investing is a means to an end but not an end in itself. Accumulating wealth to reach specific goals allows us to experience maximum satisfaction from our money. The financial planning process helps to refine goals and then lays out the steps to reach them. However, few people have the knowledge or experience to craft a comprehensive plan. Retaining the services of a qualified financial planner to create a plan will increase the probability of reaching those goals.
  
  
• Manage Risk – Even with a financial plan, there is not 100% certainty that financial goals will be achieved. Reducing risk is essential. For example, financial diversification is a time-tested risk reduction strategy. Diversification means spreading financial assets across various savings and investment vehicles, assuming that when one is down, another will be up, thereby reducing the risk of overall loss in a financial portfolio.
  
  
• Avoid Predicting Returns – Yogi Berra famously said, “It's tough to make predictions, especially about the future.” In fact, it’s so tough that no one can do it reliably. Unfortunately, naïve investors sometimes think there is a “sure thing” out there that will yield a big payday. The best advice is to understand what you are investing in so you can make educated guesses about where to put your money. For example, many experts recommend index funds that invest in broad swaths of the market so the ups and downs of individual stocks even out over the long haul.
  
  
• Practice Dollar Cost Averaging – All asset types go up and down in value over time. Even if an investor does adequate homework and has made a thoughtful investment, volatility comes with the territory. Experienced investors often employ dollar cost averaging, buying consistently over time during both highs and lows. This means more shares are purchased when prices are low and fewer at higher prices. The typical result is better earnings over time.
  
  
• Factor in Tax Impacts – Rookie investors must learn how to assess the effect of taxes on their savings and investment returns and act accordingly. For example, buying and holding a stock for more than a year before selling means the IRS only assesses taxes at the capital gains rate. Earnings on the sale of an investment held less than a year are considered ordinary income and taxed at a higher rate.

Parents may “seed” their child’s investment account with a financial contribution. From this starting place, the novice investor often has more options. However, even without such a contribution, passing along the knowledge from a lifetime of money-related successes and failures can provide invaluable guidance.

Life Insurance and Annuities

A traditional way parents help their child financially is to purchase life insurance or an annuity. (Grandparents can do this for grandchildren, also.) This can be done whether the child has reached adulthood or not.

For life insurance, there are two common approaches.

First, the child is the policy’s designated beneficiary, thereby receiving a death benefit when the insured (parent) dies. Death benefit payouts from life insurance policies are generally tax-free, so some parents see this as an efficient way to pass wealth down to their children.

Second, a life insurance policy can be opened as a gift where the child is the insured party. The policy can be either term or whole life. Term insurance is limited to a death benefit only. It remains in force for its contractual length (e.g., 20 years), assuming premium payments are not missed. Since most gifted life insurance is liable to be whole life, this chapter will focus on that type.

Whole life offers a death benefit plus a cash value component. A portion of every whole life premium paid adds to the cash value, so it builds up over time. Gifting a whole life policy has several advantages.

• It provides both a death benefit and a way to accumulate money.
• The cash value component can be tapped through either loans or withdrawals to pay for such things as a house downpayment or education costs. However, withdrawals often reduce the death benefit.
• The younger the insured, the lower the premium costs. Whole life premiums often don’t change over time.
•  Having the policy guarantees insurability even if the insured develops health issues in the future.
•  A policy eventually becomes “paid-up” with no further premiums required depending on the contract terms.

Here’s how to buy a whole life policy for someone other than yourself:

• Upon identifying a policy meeting your specifications, “insurable interest” must be proven. This means a financial loss in the event of the insured’s death. In the case of a minor child, this would be medical bills or funeral expenses. For adult children, the possibility that they could care for aging parents in the future can also qualify as an insurable interest.
• Obtain written consent from the proposed insured. A parent or legal guardian’s written consent is required for a minor child.
• Depending on the insured’s age and health status, a medical exam may be required.
• Once the policy is in force, make all premium payments to prevent it from lapsing.
• When an insured minor reaches the age of majority, then ownership of the policy can be transferred to their name.

Annuities are contracts that guarantee a lifelong income flow in exchange for payments made into the contract. A deferred annuity makes the most sense when a parent buys an annuity for a child (or grandparent for a grandchild). Under this kind of contract, the buyer pays into the annuity over time, and then payments flow out to the annuitant (child or grandchild) starting at a specified age.

The advantages of a deferred annuity are:

• Provides guaranteed income for the rest of the child’s lifetime
• Since the payout is spread out over time, it prevents the recipient from undisciplined spending

The downsides of a deferred annuity are:

• Payments are fixed and won’t keep up with inflation
• If circumstances change, annuity contracts are difficult to cancel

Life insurance and annuities can be great ways to help adult and minor children financially. However, both come with high fees, are often inflexible contractually, and are only as safe as the companies that offer them. Buyers must understand all the pluses and minuses before committing to either of these financial products.

Real Estate

Gifting real estate to an adult child is another way to help financially. A classic example is when mom and dad downsize, they gift the family home to the adult child or sell it to them at a deep discount. Here are more details on those two common scenarios.

Scenario 1: Parents gift an adult child the family home worth $400K.

Tax Implications: Since the gift exceeds the 2023 $17,000 threshold, the parents must complete the gift tax reporting form (See Helping Adult Children Financially: Part 1 - The Basics for more details). The adult child recipient pays no taxes on the gift until the property is sold. If the property is sold ten years later for $550K, the seller pays capital gains on the $150K increase in value.

Scenario 2: Parents sell the family home worth $400K to an adult child for $250,000.

Tax Implications: This transaction is called a gift of equity. In the year of the transaction, the parents can write off the $150,000 difference as a loss. In that same year, the new homeowners had no tax consequences. However, like Scenario 1, capital gains will be payable on any amount over $250,000 when the property is sold in the future.

There are other options, like adding an adult child to the deed. Whatever the approach, however, it is essential to retain a real estate attorney to help craft the deal. This will prevent unforeseen legal or tax effects that could turn a well-intentioned act of generosity into a massive headache.

Starting a Business

Parents may be thrilled that their adult child has the vision and drive to start a business. On the other hand, they may have a big decision when their daughter or son asks for financial help to get the new venture off the ground.

Parents need to answer some essential questions:

Is this something to get involved in? There may be a strong motivation to support your offspring, but what will be the consequences of helping? Is the venture something you believe in apart from your love for your adult child? If you don’t help financially, will that cause hard feelings? These are emotional decisions that need to be sorted out first.

There are practical considerations, also. Parents should request a business plan and ask hard questions. If the plan (or lack thereof) raises concerns, you owe it to yourselves and your adult child to have a frank discussion about any deficiencies.

Can we afford this? Even if you have confidence that the venture has potential, is the money there? If the support is an outright gift, the money is gone from the parental account whether the venture succeeds or fails. If it’s a loan or investment, the fact that most small businesses don’t survive in the long term means that money may never return. In any case, think carefully about your financial health before taking a flyer on the new business.

If the answer is “yes” to the two questions above, then ask the budding entrepreneur these further questions:

• How much money is needed?
• How will it be used?

There is also a question about the form of financial support, be it a gift, a loan, or an investment. Each of these options carries tax implications for both parties.

Given this and other steps in setting up a new business, parents should insist on involving an attorney experienced in these matters. No matter what the form of financial support, having legally binding documentation will provide clarification for all parties and (hopefully) reduce the prospect of conflicts as things progress.