In case you’re unfamiliar with doctor pay, there are two different tier systems: Resident physicians and attending physicians. Resident physicians are doctors who recently graduated from medical school and are still getting training in their field of choice. They are working as doctors but still actively learning at the same time. Attending physicians are different. They are doctors who have graduated medical school and have a minimum of 3 to 7 years of experience. They have a full state license, tend to be board certified, and make substantially more money. Resident physicians make the median household income ($55,000 to $75,000 per year). Attending physicians an average of $300,000 and beyond. If you’re a resident physician or a young professional who makes the median household income you should still invest money. Here are 4 reasons why:
1. Investing prevents your money from losing value. In case you haven’t heard, inflation is higher than it has been in awhile. Because of inflation, things like cars, homes, gas, and groceries cost more now than they have in the past. If that weren’t enough, the rate in which these prices are rising is putting a strain on our pockets and our lifestyles. We may have to delay buying the home we wanted, forgo that vacation we were planning, or drive our old cars for much longer than we anticipated. Since costs are rising so fast, we can buy fewer things with each dollar, than we could in the past. Unless we intentional about growing our money, it will continue to lose buying power just sitting in a savings account. One of the main reasons to start investing now as a resident, or young professional on an average income, is because it prevents our dollars from losing value. Investing gives our money a chance to grow which brings me to my next point…
2. Investing allows your money to grow much faster. You could stack money in a savings account, but that money will not grow much at all. The minimal increase of 0.25% that many people get by keeping their money in a savings account is not enough to keep pace with inflation and the rising cost of goods. Investing helps combat that because not only does it allow your money to grow, but it allows it to do so much quicker through compound interest. Compound interest is when your money makes more money (called interest) and then that interest stacks onto your original amount and begins to make even more money (added interest). This ability for you to make profits (interest) on top of existing profits (other interest), means that you get even more profit than you thought (compound interest). It is this compound interest that allows your money to grow much faster.
3. Investing gives you the chance to reach your financial goals sooner. Because investing allows your money to grow, it is through investing that you can accumulate a higher net worth sooner than you other wise would. As your net worth increases and the value of your investments rises you will be able to reach your financial goals sooner. For some people, these goals may be to accumulate a certain amount of money for a down payment on a home to use when they become attendings, for others it may be to have the ability to cut back to part time or just work one less day per week. Whatever your financial goals are, investing gives you the opportunity to reach them sooner. As your net worth grows, you start to accumulate wealth and one of the best things money can buy is control over your time. Think about how nice that would be.
4. Investing allows you to invest as you save. This is perhaps one of the biggest perks of investing as a resident or young professional. Investing money through a Roth IRA (that you can open by calling a place like Vanguard or Fidelity) gives you tons of options including the ability to invest as you save. What do I mean by that? You can contribute money to a Roth IRA then choose to invest it however you’d like (preferably in low cost index mutual funds like VTSAX or VIT). With a Roth IRA, you also have the option to take your contributions out of the account at any time. This means you can open a Roth IRA and contribute $500 per month up to the yearly maximum of $6,000 per year. During your time in training and career building this money is growing and gaining compound interest. Once you finish training you can choose to take your contributions out of the account (and use the money for a wedding, fancy vacation, or down payment on a home) but keep the profits you made on that money inside of the account. In other words, you were able to make money on your investments and still save for the big item you planned for. You can also choose not to take out your contributions and instead keep all the money inside of the Roth IRA until you retire. Having the option the take your contributions out of the account at any time allows you the flexibility to use this account as a backup savings account that actually earns interest.
What do you think? If you’re a resident physician or young professional making the median income, will you start investing money this year?
New Goals for the New Year (2022)
It’s 2022 and many of us want this year to be better than last year. Instead of just hoping this happens, let’s make some realistic goals and put steps in place to achieve them. Here are some of my 2022 goals:
1. Continue to invest at least 10% of my salary in retirement accounts. Investing money gives me the opportunity to allow my money to grow. Because of inflation (the rising cost of goods and services) money sitting in a savings account is actually losing buying power by the day. In order to prevent this, I keep a certain amount of money in an emergency fund and make a habit to invest the rest. Since I know I can’t be relied upon to actively put the money into investment accounts each month, I make it automatic by having 10% of my paycheck automatically invested into my work 403b (similar to a 401K) before the money hits my bank account. I also have a set amount automatically invested into my Roth IRA. You can do the same thing. The amount you choose to invest is up to you, but having automatic contributions into your 403b or Roth IRA will allow you to start building wealth long before you retire which will create more options for you in the future.
2. Make more money from side hustles (increase passive income). As a senior resident physician who is starting fellowship next year, I haven’t gotten the “big bucks” just yet. I make more than I did as a first-year doctor, but I still haven’t gotten that attending salary boost. Although I’m anxious to get paid more, I refuse to put my life on hold for a year and a half until that time comes. While many people choose to moonlight (work extra shifts as a physician) to supplement their income, I’ve always been concerned that doing so might cause me to burnout from medicine. So, I've tried to increase my income a different way. For me, that means monetizing my hobbies and increasing passive income. I’ve made tens of thousands of dollars doing that as a resident physician and would encourage other docs to consider passive income ideas, or monetizing some of their hobbies, to increase their monthly income as well.
3. Avoid accumulating consumer debt. When I first started residency, I had lots of credit card debt. Most of it I accumulated before I went to med school. I was unable to pay it off while getting my degree so when I graduated and started residency, I still had it. My credit card interest rate was 10% which means that each day I had the debt I was being charged extra money in interest. It didn’t take me long to realize that the sooner I paid off the debt the more money I’d save in interest fees. When I got my first job as a doctor, I prioritized making large credit card payments and paid off the debt in less than a year a half. I’m still credit card debt free, so my goal for this new year is to avoid accumulating more. It can be so tempting to use my credit card to book flights, pay for vacations, and purchase other items on sale but resisting that urge has served me well. In 2022 I hope to continue this practice.
4. Save money for future vacays. In order for me to avoid accumulating credit card debt one of the things I do is plan ahead. I save money in advance for large expenses like vacations, travel, holiday gifts, and friends' weddings so that I don’t end up charging these expenses on a credit card. I also have a percentage of money from each paycheck deposited into an entirely different bank account. I use the money in this bank account to save for future large expenses. Having these automatic deductions into a separate bank account prevents me from having to rely on my memory or self-control. I plan to continue this same practice in 2022.
5. Carve out time for self-care. As a senior resident physician who will be starting fellowship next year, life is busy and occasionally stressful. One of the ways I plan to decrease stress and improve my own wellbeing is by investing in self-care. For me, that means reading more books, finding time for rest and relaxation, having periodic therapy sessions, and maintaining healthy eating & exercise habits. Life can be hectic, but making the time for my own self-care and happiness is better for my overall mental health and longevity.
Tell me, do you plan to do some of these things this year? What are some of your goals for the new year?
5 Things To Do Before The New Year
1. Show gratitude for good health in the midst of this pandemic. Whether you’ve made a full recovery from coronavirus or have been one of the lucky few to have never gotten infected, you’ve made it to the close of another year. Show gratitude. We are alive and healthy enough to make a living, be in our right mind, and make it through the Christmas holidays. That is a blessing. Good health is one of the things many people take for granted while they are young and spend a fortune trying to maintain when they are older. Be different. Part of showing gratitude for good health means making a commitment to take care of your body and preserve that health for as long as you can. Enjoy the holidays but make a commitment to exercise, eat healthy, and maintain a good mental state going into the new year.
2. Practice good self-care to become a better version of yourself. It’s not enough to just have good health habits. You also have to put in the work needed to become a better version of yourself. You are too smart and have too much potential to stay stagnant. You have to grow. And in order for you to grow, you have to practice good self-care and commit to getting better. That means doing what it takes to improve mentally, emotionally, physically, intellectually, and financially. You may have to hire a personal trainer, see a dietician, get a therapist, take a few courses, read some new books, and surround yourself with a social circle who will motivate you to strive for more.
3. Get optimistic about next year and refuse to stress about the unknown. You’re a young professional with a promising career, good health, and a sound mind. There’s nothing you can’t do. Instead of worrying about your job, your bills, or other things that used to cause you stress, adopt a new mindset. Before this year ends, make a commitment to write down some goals for next year. And dream big. Think of what you plan to accomplish, the money you plan to invest, the places you intend to travel, the people you hope to impact. Then visualize it. Picture yourself doing all these things and think about how it would make you feel.
4. Reaffirm your commitment to invest money and grow your net worth. If you’re like most people you desire to live a life of significance and get paid to do work that you enjoy. Perhaps you also want to travel the world, spend time with family, and live in a nice home. Your ability to do these things will be much improved if you build your net worth. The more money you have, the less dependent you will be on your job and the more options you will have to live life on your own terms. Make investments now to give yourself that chance. Set aside 10-20% of your income for building wealth and use that money to invest, pay down debt, and save for large purchases. One of the best things money can buy is control over your time. Do what it takes now and make the necessary investments to build your net worth so you can live the life you desire.
5. Never forget the importance of faith and family. Maya Angelou once said, “People will forget what you said, people will forget what you did, but they will never forget how you made them feel.” So do your best to let your family know how much they mean to you. Regardless of how much money you have, regardless of the type of career you build, or the kind of possessions you acquire, it’s vital that you remember what’s important in life. The love and support of your family/friends along with your faith and positive belief that you are here for a purpose and can do anything you put your mind to is vital. Take the time to tell people how much you love and care for them this holiday season and renew your faith in God who has allowed you to make it to this moment and all the future moments to come. Finish 2021 off with a bang and head into 2022 with a plan for this to be your best year yet.
6 Reasons to Understand How your Money is Invested
I love to read books, listen to podcasts, and watch videos on personal finance, but some of you may prefer to hire someone to take care of that for you instead. And that’s okay. Whether you decide to manage things yourself or get a financial advisor, it is vital that you understand the basics. Don’t blindly follow someone else’s investment plan without fully understanding it and don’t naively trust a financial advisor to have your best interest at heart. No one is going to care more about your money than you. Before this year ends, make sure you fully understand what is happening with your money. This is why:
1. To ensure you are not being taken advantage of. Many doctors and young professionals who are unaware of how their money is invested and know very little about personal finance get taken advantage of by people they thought had their best interest at heart. They may overpay for things, have their money invested the wrong way, or be overcharged for assistance in managing their assets. When people know you have more money, they tend to raise their prices and fees because they assume “you can afford it.” Having some knowledge of personal finance will allow you to better discern if you are getting charged a fair price for good advice, or not.
2. To ensure you aren’t being charged high fees that decrease your investment returns. In order to have your money grow over time, it needs to be invested. When you invest money, you usually do so by purchasing assets that will increase in value over time. The cost of acquiring those assets can vary but the key is to make sure the fees you are being charged to have those assets are not too high. This is especially true when it comes to real estate and the stock market. Overpaying for a home or investment property can cause you to lose money quicker than you think. Investing in mutual funds (groups of stocks or bonds) with high expense ratios can cut into your profits and minimize the growth of your money. For example, if the average mutual fund has a yearly increase of 8% per year but inflation is 4%, the fund fee is 1% and your advisor fee is 1% then the growth of your money is really only 8% minus 6% which is 2% per year. We cannot control inflation but minimizing the fees we are charged on our investments is within our control. Be aware of what you are being charged for certain investments and make sure it isn’t too high.
3. To ensure you are not invested in things that underperform the market. Another disadvantage of not understanding personal finance is having the wrong investments. Although personal finance is personal, double check that you are actually making good investments, which I define as things that have a high chance of increasing in value over time. There are lots of “good” investments but there are also investments that underperform the market or change in value too frequently to be useful. Learning about personal finance helps ensure that you are investing in things that will increase at an appropriate rate over time.
4. To ensure your investments aren’t just things that provide bonuses and commissions to your advisor. Believe it or not, there are some advisors who will use your money to enrich themselves. They will come to you claiming to help, all the while investing your money in questionable ways and buying products that result in a large commission to themselves at your expense. Although some are sneaky, others have simply been trained or groomed to believe that the things they sell are good. They attended a seminar or class that taught them all the potential benefits of certain products without mentioning the drawbacks of the investments they offer. As a result, they come to you with good intentions but bad information. They may try to talk to you about the benefits of whole life insurance and conveniently fail to mention the large commission they get for selling you the policy. They may suggest that you purchase an annuity but fail to mention the high fees and lifelong commitment to suboptimal mutual funds it requires. Having some knowledge of personal finance will help you avoid this and ensure that your advisor isn’t charging you money to enrich him or herself.
5. To ensure your investments align with your risk tolerance and investment goals. Another perk of knowing about personal finance and investing is being able to ensure that you are investing in ways that give you a good chance to make a profit (with little fees) with minimal risk. You want to make sure you aren't invested too heavily in one thing. It's also important that you plan for the unexpected. If you switch to a low paying job, your child care expenses increase, or the stock market or real estate industry crashes again, do you have room in your financial plan to handle it? You need to take some risk in order to make a profit but be careful not to take too much risk. You don’t want to lose all you have over one unexpected event. Diversify your investments, buy assets in different industries and consider using the combination of stocks bonds and real estate to protect yourself against the unexpected.
6. To ensure that you know your true net worth. As you continue investing and building wealth you should be keenly aware of not only what you are investing in but also where you are in your journey to financial independence. This means you should be able to calculate your net worth. If you stopped working today, how much money would you have? What is the total amount of your assets (the things you own) minus your liabilities (the debt you owe)? If you didn’t make any more money, how long could you still afford your current lifestyle? Are you reliant on your next paycheck or do you have enough money saved and invested to continue to live life and function as you do now? Part of being money savvy is not living paycheck to paycheck. It’s not being dependent on your job. It's being aware of where you are in your wealth creating journey. What is your net worth?
7 Principles to Help You Start Investing
We all have friends and family members who are investing money. Whether it’s stocks, bonds, real estate, or cryptocurrency we all know a few people who are investing. And this is a good thing.
Why? Because we can’t save our way to wealth or financial freedom. We must invest.
Although savings accounts may be “safe,” keeping all of our extra cash in those accounts may not be wise. Money sitting in a savings account won’t grow fast enough or accumulate quickly enough to allow us to meet our money goals. Plus, because of inflation, things cost an average of 2-5% more each year. This means that one dollar today will only be able to buy you 95cents worth of stuff next year. As things increase in cost each year, the amount of things you can buy for one dollar decreases, so you lose more and more purchasing power each year. In order to overcome this “inflation effect” we must find ways to make our money grow.
This brings us to investing.
Investing is when you purchase assets or things are likely to go up in value. Buying assets allows our money to make more money over time.
But… you must know what you’re doing.
Investing money without fully understanding what you are purchasing and how it works can cause you to lose money quicker than you think. Instead of feeling like you have to know everything about every investment, commit to learning a few of the basics:
Principle #1: One of the easiest ways to begin investing is in the stock market.
Unlike real estate investing which has lots of moving parts and requires a unique skill set and high startup capital or investing in cryptocurrencies that use newer technologies that can challenging to understand or who’s intrinsic value changes drastically, investing in stocks and bonds is often much easier.
Principle #2: When investing in the stock market, it is much safer to seek average profits with minimal risk of losing money than to aim for extraordinary profits with a high risk of losing money.
In order to obtain average returns (8-10% per year) with minimal risk, it is wise to invest in diversified index mutual funds. Let’s break down what this means:
A mutual fund is a group of investments (like a group of stocks or a group of bonds). Instead of buying one stock or one bond in a specific company like apple or tesla, buying a mutual fund means that you purchase a group of investments (that contains a percentage of stocks from apple and tesla and many other companies altogether). In other words, instead of one whole stock, you have a mutual fund that has a little piece of many different stocks.
An index mutual fund is a specific type of mutual fund (group of stocks or bonds) that follows an index. This means the amount and percentage of stocks that are contained in this group are similar to those that are tracked by other validated measures and meet a certain set of requirements. Examples of indexes are: the Standard and Poor 500 also called the S&P 500 (which is a list/index of the largest 500 companies in America). Because these mutual funds follow an index, they tend to be well diversified, which means they contain many stocks from different companies in various industries.
Principle #3: Investing in diversified index mutual funds has less risk than buying individual stocks.
If the value or stock of one company decreases, then stock in the other companies can lessen the impact of that decrease. Thus, with an index mutual fund the value of your investment tends not to change as often. Because you are have a percentage of stock in many different companies you have room to capture increases in stock value from many different companies at the same time. It is impossible to predict which companies will have stock that increases in value each year instead of staying the same or decreasing in value. Index mutual funds offer a shield of protection along with added opportunities for growth that combat this uncertainty. Instead of having to buy individual stock in 500 companies, you can just buy the index fund and have a percentage of stock from all the companies for a much cheaper price. If the value of apple goes up, so does your investment. If the value of another company within that index fund goes up so does your investment.
Principle #4: Pick some of the most common index mutual funds and realize that different brokerages can have similar index funds that are called different names.
Many people may understand in theory what an index mutual fund is, but they may not know which one to invest in. In order to combat this problem many people invest in a lifecycle or target retirement funds. They may even pick a simple 3 fund portfolio (which means they invest in 3 different indexes at the same time). The goal is to invest in the index funds that have done the best over time, that are validated, that tend to have the highest returns year after year. That would be a combination of 3-4 different types of indexes:
A Total United States Stock Market Index (an index that buys a percentage of all of the stocks in the United States)
A Total International Stock Market Index (an index that buys a percentage of the stocks from companies all around the world)
A Total United States Bond Index (an index that buys a percentage of almost all of the bonds in the United States)
A Total International Bond Index (an Index that buys a percentage of almost all of the bonds from across the world)
You can get a version of each of these types of indexes at various brokerages (firms that allow you to buy stock). For example, the Total US Stock Market Index Fund at the Fidelity brokerage is listed under the symbol FSKAX and the Total US Stock Market Index Fund at the Vanguard brokerage is listed under the symbol VTSAX.
The percentage that should be invested in each of these indexes depends on the person.
Principle #5: The general rule of thumb is to have most of your money invested in stock index funds and a smaller percentage in bond index funds.
I have about 90% of my work retirement money invested in stock indexes (with 60% in the U.S. Total Stock Market Index Fund and 30% in the International Stock Market Index). I have the remaining 10% of my work retirement fund invested in bond indexes (with 8% in U.S. bonds and 2% in international bonds). What is right for me may not be right for you, so you should determine your own percentages.
Once you know why you must invest and you understand what to invest in, you must then understand a couple more things:
Principle #6: The stock market will experience ups and downs, but over the long haul, it continues to increase in value. It is better to invest consistently over time than to try to pick and choose the best times to buy and sell your investments.
Continuing to invest consistently despite the market fluctuations (changes in stock values from day to day) will prove to be more valuable to you than trying to “time the market” or invest only at certain times when the market is reacting in certain ways. It is more lucrative to buy when things are priced low (when the market is experiencing a downturn) and sell when things are priced high (so you can maximize your profit) but trying to time the market is hard to do since no one can predict the future. Attempting to time the market often results in lower profits than if you had just invested consistently over time because it’s nearly impossible to which days certain stocks will be low in value vs high in value.
Principle #7: Your money makes more money over time via compound interest so investing consistently over many years will help you to build wealth and meet your financial goals.
It often takes years to reach that first milestone of $100,000 but much less time to reach the next milestone of $200,000. Time is your friend. Trying to get rich quick often results in losses and can lead to poverty and debt. Be patient and consistent. Invest.
5 Truths Every Resident Needs To Know
July 1st is just around the corner and for those who are new to medicine or unfamiliar with residency life, July is the start of the new resident physician year. A resident physician is a doctor who graduated from medical school and is getting specialized training in his or her field of choice while still seeing patients. Residents are doctors who are still actively learning (like a student in school) while they are also working and earning money.
Besides experience, the main difference between a resident physician and a regular physician (like an attending physician who is done with his/her specialized training) is that resident physicians work a lot more and get paid a lot less. I’m still a resident myself, so as you can imagine, it’s a busy time in our lives. There are a lot of things we have to worry about, but finances shouldn’t be one of them. Here are 5 money-related truths every resident physician, and young professional with high earning potential, needs to know:
You are not guaranteed to be rich. Just because you are a doctor and will have a high salary, does NOT mean you don’t need a plan for your finances. Most people who make more money, get into more debt. Your time as a resident is not an excuse for poor money management and credit card accumulation. Many doctors’ net worth is not nearly as high as it should be considering how much they get paid. Make some financial goals for yourself now and try to avoid some common pitfalls. Learning a few finance basics as a resident can go a long way.
Spend less. Save more. Minimize debt. Things can be challenging during residency so try to live below your means or at least avoid living above your means. You don’t have to have a detailed budget but creating a basic spending plan to prevent yourself from accumulating [more] debt during training might be helpful. Save money in an emergency fund so that small, unexpected expenses like a car repair, urgent trip back home, or new cell phone doesn’t derail your budget or financial goals. Vacations can serve as a much-needed break from the stress of residency, but try to pay for them in cash by saving a couple hundred dollars from each paycheck. If you can, invest some money in index mutual funds via your work retirement plan or your own Roth IRA. The goal in residency is to keep your head above water financially and avoid getting into more debt.
Have a plan for your student loans. Choosing to “deal with it later” is NOT a plan. Read about the different student loan repayment options and choose one, likely an income-driven repayment plan, so that your payments are affordable in residency. Most residency programs qualify for public service loan forgiveness so take a couple minutes out of your day and sign up for this free program so that you have an option for your student loans to be forgiven after 10 years. When choosing a student loan plan recognize that the optimal student loan plan for you as resident may change when you become an attending. That’s okay. Just figure out the best federal repayment plan for you now, likely PAYE or Re-PAYE and consider hiring a company like Student Loan Advice or Student Loan Tax Experts once you finish training so they can run the numbers for you and help you determine the best repayment plan for you as an attending.
You need Insurance. As a resident physician, there’s a good chance you have health insurance from your employer that is either free or low cost, but health insurance isn’t all the insurance you need. Every resident physician needs long-term disability insurance. You may get a small amount through your residency program but that is unlikely to provide enough coverage. Most residents and attendings will need to purchase an additional individual long-term disability insurance policy. If you have a spouse, kids, or family members that you support financially, you may also need to purchase term life insurance. If you have a side business, you may also need extra liability insurance coverage. Figure out all of the insurances you need and make sure you get them.
Think twice before you buy a house. Owning a home can be a major milestone and lifelong dream, but it may not be wise to do so in residency. You cannot just compare the monthly mortgage price to the monthly rent price and make your decision. There are additional fees and costs associated with home ownership that can be challenging to deal with as a resident. Do what is best for your family, but make sure you consider all of the pros/cons of buying a home before you make the decision to rent vs buy.
Want to Invest Money for Your Child? Consider a Custodial Account
Many parents want to set their kids up for financial success. One of the best ways to do that is to invest money on their behalf. Although there are many different investment accounts to choose from, consider opening a custodial account for your child.
What is a custodial account?
A custodial account is a type of account you can open to invest money on your child’s behalf. Technically speaking, there are two main types: A UGMA (Uniform Gift to Minors Act) and a UTMA (Uniform Transfer to Minors Act). With a UGMA, you can invest money in securities like stocks and bonds on their behalf. With a UTMA, you can invest in securities like stocks and bonds along with additional things like real estate or even put tangible assets like properties and businesses in your child’s name. A UTMA allows you to do everything that UGMA does, plus more. (UTMA’s are not offered in every state so some people are limited to a UGMA).
How does it work?
You call up a financial institution, like Fidelity, Vanguard, TD Ameritrade, etc, and let them know you want to open a custodial account for your child. The account will be in your child’s name and you will be the “custodian” or the person controlling the account. You then put as much money as you want into the account as often as you’d like to invest. Once your child hits the legal age of maturity (which ranges from age 18-21, depending on the state) they get all the money in the account. Some states like Florida, give you the option to delay the age in which your child gets the money until age 25, if you want.
What are the advantages?
It allows you to invest money for your child. By investing money, instead of merely saving it, you will be able to stack up more money for your child over time. If you saved $25 a month for your child starting from the time they were 5 years old, by the time he or she turned 21 you would have stacked $4,800. However, if you had instead invested that money (in index mutual funds which make an average of 10% per year) by the time your child turned 21, he or she would have $10,780. That is more than double what you would have if you only put the money in a savings account!
It provides more flexibility than other investment accounts. Unlike other investment accounts that you can open for your child (like a 529 account or a Roth IRA), with custodial accounts there is no rule on what your child can or cannot spend the money on. If they decide to go to college, they can use it for college. If they want to open a business, they can use it for that. If they want to spend ½ of it to buy a home and the other ½ to pay for their wedding or fund a travel experience overseas they can do that too. It’s your child’s money to do as he or she wishes.
There is no contribution limit. With a custodial account there is no income limit on who can and cannot contribute to the account (like there is with an Educational Savings Account) and there also is no limit to how much or how little you can put into the account each year (like there is with a Roth IRA). It doesn’t matter if you are rich, poor, or somewhere in between, anyone can contribute any amount of money to a custodial account as frequently or infrequently as they want on behalf of their child. Contributions over $15,000 per year will trigger the federal gift tax, but technically speaking you can put as much money in the account as you want. That is not the case with some of the other investment accounts.
What are the drawbacks?
Like almost any type of account, there are things to be cautious of if you decide to open a custodial account on behalf of your child:
The money is your child’s to keep and you can’t take it back. If you are in a financial bind and need money for an unexpected car repair or to repay debt, you cannot withdraw money from the custodial account to do so. When you contribute money to the account you are legally giving the money to your child. This means you cannot take the money back later if you want to. It belongs to your child.
Your child can spend the money on whatever he/she wants. Once your child hits the legal age of maturity, it is their money to spend how they want. While this gives them lots of flexibility, it can be problematic without the right discipline. You may want your child to spend the money on college expenses or a home down payment but he or she may instead choose to spend the money on a fancy car, blow the money on drugs and clubs, or lose it all gambling.
You have to report it on your tax forms and any financial aid forms for school. Since it’s an investment account that makes money, technically speaking, your child must pay taxes on the profit made from investing in the account. Any profits made in excess of $2100 per year is taxed at your (the parent’s) income tax rate. You can choose to pay taxes on your child’s behalf. You can also minimize any taxes owed by investing in low-cost index funds and simply waiting until your child reaches the legal age of maturity to sell any investments. However, if your child goes to college, he or she will have to report any assets they have (including money in this custodial account) to the school which may decrease how much financial aid he or she is eligible for.
Given the drawbacks is it still useful?
Many people think so, but that’s a personal decision that you have to make for yourself. If you know your child will blow the money on drugs and parties then perhaps a custodial account isn’t the best place to invest the money. If you aren’t sure if your child will go to college or anticipate they may need money to pay for a wedding, buy a car, or start a business in the future, then perhaps a custodial account is a good place to invest money.
If you invest money in a custodial account then realize that your child wants to go to college (or think they may be irresponsible with the money in the custodial account) you can use the money to pay for college directly or transfer money from the custodial account into a 529 college account in their name. My point? Custodial accounts can be useful and you can invest in them in addition to other investment accounts like a 529 college savings account or a Roth IRA.
Tell me, would you consider opening a custodial account for your child?
Plan for the Unexpected
If there’s one thing I’ve learned as an adult it’s that sometimes things just happen. You may think you are on track with your career, your finances, or your personal life, but life has a way of surprising us. Sometimes these unplanned events are good. We get a promotion at work, another stimulus check from the government, or an impromptu visit from a friend we haven’t seen in a long time. But other times, these surprises are major problems we couldn’t have predicted or avoided, especially when it comes to finances.
You may be costing along, saving and investing a certain percentage of money and then something unexpected happens. Your car breaks down, your laptop dies, or something urgent comes up that requires your time, attention, and money. Up until a few years ago, these unwelcome occurrences would get me down and make me anxious. I’m a planner who would get frazzled whenever things deviated from how I envisioned.
In order to decrease my anxiety, and feel better prepared, I needed to start planning for these inconveniences, at least the financial ones. I used to just rely on my emergency fund, but then I realized I was needing to dip into that fund a little too often, so I had to put a better plan in place.
My solution was 3-fold:
Cut back on unnecessary spending elsewhere. I re-examined my budget and tried to think about ways I could cut back. For me, it was decreasing the amount of money I spent each month on food and wine, especially when I’d travel out of town. I set a preliminary spending limit every time I went to a restaurant so that I wouldn’t go overboard. I also began to cook more at home and was more diligent about searching for discounts whenever I’d travel out of town.
Set extra money aside each month. For me it was $200. Whenever I got paid I’d automatically plan for $200 to be gone in “incidentals.” If I didn’t have to spend the money one month then I could use it however I pleased but if I did need to spend the money then at least doing so wouldn’t totally wreck my budget. Having money set aside for these unexpected expenses made me less stressed when things would come up.
Increased my income. While I was waiting to see if I’d get a raise at my main job, I took matters into my own hands. How? By trying to make more money from other income sources. Whether it was working extra shifts at the clinic or trying to monetize my hobbies and side hustles, I tried to increase my income so that unexpected expenses wouldn’t totally destroy my budget and savings goals each month.
Do you also have added expenses that come up each month that throw you off your game?
If so, the solution isn’t to just charge the expenses on a credit card and hope to pay off the card someday. You may want to adopt a plan similar to mine so that you are more proactive and less reactive when/if these unexpected expenses occur.