Nerd Gone Wild

Jonathan Clements

IT’S LONG BEEN an idea that’s captured my imagination: Get a child invested in the stock market at a young age and then leave compounding to work its magic. If stocks notch four percentage points a year more than inflation—which many would consider a conservative estimate—$10,000 invested at birth would be worth $230,500 at age 80. That sort of success would, I suspect, give a significant boost to parental popularity.

When my kids were born, I set out to turn this nerdy financial dream into reality. I was on a junior reporter’s salary, with a wife in graduate school, so it took a few years to get rolling. But eventually, I settled on a five-part plan to help Hannah, now age 28, and Henry, now 24.

What were the five parts? I would make sure Hannah and Henry graduated college debt-free, and give them $5,000 upon graduation, $20,000 for a house down payment, $25,000 for retirement and $5,000 toward a wedding or at age 30, whichever came first. I didn’t have this sort of money lying around, so it took many years of regular savings to hit these targets.

Earlier this year, I wrote about Hannah’s engagement—and mentioned my five financial commitments. That blog prompted a slew of emails. How, readers asked, did I go about doing all of this?

For the graduation and wedding money, I didn’t set up separate accounts. Instead, those sums sat in my money-market fund. Meanwhile, college costs were partly covered by money I had socked away first in custodial accounts and later 529 college savings plans, once those became available. Still, I probably paid three-quarters of college costs out of current income.

What about the $20,000 in house money? Hannah’s future down payment went into Vanguard Target Retirement 2010 Fund, while Henry got Vanguard Target Retirement 2015. The target funds kept things simple, offering a diversified portfolio in a single mutual fund. On top of that, I knew the funds would become less risky over time—an appealing attribute, because I wanted the money easing out of stocks as the day approached when the kids might purchase a home.

I bought both funds in custodial accounts. That wouldn’t be a smart move if you thought your children had a shot at receiving college financial aid, because custodial accounts weigh heavily against you in the aid formulas. But I was confident our family wouldn’t qualify. Hannah cashed in her target date fund in 2015, when she bought her house in Philadelphia. I provided additional help by writing a private mortgage for her.

What about the $25,000 in retirement money? That was trickier. To contribute to an individual retirement account, you need earned income. I’ve heard of parents who have funded Roth IRAs for their children, based on income that the kids earned from babysitting and mowing lawns.

Neither of my children earned much money until they were well into their teenage years, so I went hunting for a tax-deferred account that didn’t require earned income. Result: When Hannah was age nine and Henry was five, I opened a Vanguard Group variable annuity for each of them.

Variable annuities, of course, have horribly high investment expenses. But Vanguard’s offering is an exception, with an average all-in cost of 0.54% a year, versus a 2.27% industry average. The minimum investment for Vanguard’s variable annuity is $5,000. There’s a $25 annual account fee if the balance is below $25,000—which is why I settled on that as my target gift. The variable annuities were set up as custodial accounts, with me as custodian. Once Hannah and Henry turned 21, I transferred the accounts into their names.

Later, when they started earning money, I opened Roth IRAs for them. A Roth is obviously preferable—expenses should be lower and you get tax-free growth, versus the variable annuity’s tax-deferred growth. Still, for younger kids, a low-cost variable annuity strikes me as an intriguing option: They’ll enjoy tax deferral on a grand scale—and the tax penalty will discourage them from cashing in the account before age 59½. One additional feature I like: Vanguard’s variable annuity allows you to set up automatic rebalancing. That means Hannah and Henry’s accounts will likely stay on the course that I set many years ago—without any further involvement on my part.

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