No More Handouts, Kid

If you're planning to give your children financial assistance after graduation, make them work for it. Here's how.

AT GRADUATION CEREMONIES ACROSS the country this month, tears will stream from proud parents' eyes as they watch their sons and daughters, dressed in caps and gowns, accept their college diplomas. As their child's name is read aloud by the dean, these parents will sadly acknowledge that their baby has officially crossed over to adulthood.

What's next for their grown-up offspring? Well, that's a no-brainer: They're moving right back in with mom and dad.

At least that's the plan for a whopping 60% of this year's graduating class, according to a survey conducted by MonsterTRAK, part of career Web site Sure, some kids will say this is just a temporary situation while they look for gainful employment, but consider this: 45% of last year's graduates are still living at home.

These days, graduating from college might symbolically mark a child's entrance into the adult world, but in reality, many kids aren't ready to leave the nest. It isn't necessarily their fault. "If you look at the high cost of living and at the fact that (new graduates) usually carry about $19,000 worth of student-loan debt, and then you add the credit-card debt that they've accumulated, they simply can't afford to live on their own," says Michelle Forker, senior vice president of Monster Campus, a division of Monster. "So there really aren't a whole lot of options."

But that doesn't mean the parents of a recent graduate should continue with the free handouts. "There's a danger in coddling your children too much," says John Nersesian, a Certified Financial Planner (CFP) and managing director of Nuveen Investments Wealth Management Services in Chicago. "The idea that 'I have this open-ended bank account' or 'I can go to my parents for financial support whenever needed' is probably a bad (one). If a parent is going to help, it's important that this help is provided through some sort of regimented program."

Once the graduation party is over, it's time to sit down with your child and develop a post-graduation financial plan. If your child needs some continued financial assistance, here's some advice on how to dole it out -- by making him earn it.

1. Hire Your Child
No job offer for Junior? For parents who are self-employed, one solution might be to hire him into the family business. That can work out well for both parties involved.

"Hiring your kid is always a good idea because you can deduct the salary you pay them (from your business taxes,)" explains Stephen Fishman, author of "Working for Yourself: Law & Taxes for Independent Contractors, Freelancers & Consultants" (Nolo, 2004). "But you have to make sure they do real work. You can't pay them several hundred dollars an hour just for cleaning your office."

In other words, you have to treat your child like any other employee. So be sure to have her sign an employment agreement, and pay her a market-rate salary. And don't forget to withhold payroll taxes and pay half of her Social Security and Medicare taxes. For more on hiring employees for your small business, read our story.

If you don't own a business, tap your network of friends, family and business acquaintances to help your child find a job, says Bernard Bandish, a CFP with JK Harris & Company in North Charleston, S.C. "If a parent can call a high-school friend or former college roommate who happens to be an executive or manager at a good company, and can get an interview for their kid, that's better than any allowance or gift money they can give them," he says.

2. "Match" Your Child's Retirement Savings
The good news for the class of 2005 is that the job market seems to be picking up: 83% of this year's graduates expect to have at least one job offer by graduation, according to MonsterTRAK's survey, compared with 51 in 2004. But even if your child is lucky enough to count on the paychecks rolling in soon, chances are it will still be a few years before the big bucks start coming. That means important goals like saving for retirement will likely be ignored -- at least over the short term. Only 9.1% of 21- to 24-year-old workers participated in their company's 401(k) plan in 2002, according to the Employee Benefits Research Institute (EBRI). And just 2.3% owned an IRA.

But surely you've heard that the best way for folks to meet their retirement goals is to start saving early in life. "We all know, the sooner they start this process, the more compounding they earn, the better the financial results," says Nersesian. (And let's face it, there are certainly no guarantees that Social Security will await your child when it comes time to retire.)

If your child can't afford to start saving aggressively, you could help him out by matching or refunding his contributions. In other words, give him some financial reward for each dollar he contributes to his 401(k). How generous should you be? Stuart Ritter, a CFP with mutual fund company T. Rowe Price, suggests replacing the full after-tax amount your child loses by contributing to a retirement plan. (You can figure out the precise reduction in your child's take-home pay by using our calculator.)

No 401(k) plan at work? Parents can encourage their children to open an IRA account, and can match the contributions they make or provide the funds for an initial contribution, Ritter suggests. Keep in mind that a contribution is considered a gift and falls under the $11,000 annual gift limit for each parent for gift-tax purposes. (For more on the gift tax, click here.)

A final word of caution: The match offer shouldn't be open-ended, says Ritter. If the parents don't set a time limit, their good intentions of helping Junior develop a healthy habit could create an unhealthy dependency. 3. Help Junior Become a Homeowner
Many parents are inclined to assist with their child's rent payments when they first move into a place of their own. While that's generous, it could make more sense to help your child become a homeowner instead. After all, owning a home can be a savings strategy, whereas paying rent can be like throwing money out the window.

You can help your child purchase a home in a number of ways, says David Acquisti, president of the Michigan Mortgage Brokers Association. Most commonly, parents buy a second home and have their child pay as much of the mortgage and bills as they can afford. Alternatively, they can co-sign a mortgage with their child. The Federal Housing Administration (FHA) runs a low-cost program known as the "Kiddie" Condo Loan Program that offers lower down-payment and interest-rate options. In either case, once the child is financially able to cover the costs of homeownership on his or her own, the parents can deed the house over to the child, Acquisti explains.

Alternatively, parents can buy a condo or house and rent it out to their child, effectively becoming landlords, suggests Andrew Schiff of JK Harris & Company. If the unit is big enough for more than one person, the child can find roommates to help share the costs. The rent will be taxed as income to the parent, but it can be offset by the many deductions available to landlords, including the cost of maintaining the unit and depreciation, explains Nolo's Fishman, who is also the author of "Every Landlord's Tax Deduction Guide." (For more on the tax consequences of becoming a landlord, read IRS Publication 527, Residential Rental Property.)

Keep in mind: The tax implications of these strategies can be complicated and are best discussed with a CPA

4. Give Your Child a Low-Interest Loan
The average college student graduates with $3,300 in credit card bills, according to Nellie Mae, an education loan provider. It can be tempting for parents to pay off Junior's bill, particularly if he's paying outrageous interest rates. But that's probably not the best strategy, says Nersesian. "They'll tend to have this expectation that 'Mom and Dad will always be there to bail me out,' and we know that's not always the case," he says.

His advice: Consider giving your child a low-interest loan instead. "If the parents are earning 3% in a bank account, money market account or CD, they might be able to accomplish the best of both worlds," he says. "They might be able to increase their rate of return, and provide their child with a more attractive way to repay that debt." If you're considering a loan, make sure you document it and set an interest rate, or the IRS might get cranky. For more details, read our story "Loans to Family Members."

5. Donate Appreciated Stock
Rather than give your child cash as a graduation gift, you could consider gifting appreciated stock or mutual fund shares, suggests Carey Rokovich, a CFP with USAA. This provides a tax advantage to you (you're spared paying the capital gains tax triggered by a sale), and will give your child a good incentive for learning more about stock investing.

The good news: Even if your child decides to cash in the stock right away, chances are he'll owe relatively little in taxes. That's because the child's holding period will include the parents' duration of ownership for purposes of qualifying for long-term capital gains treatment. So assuming the parent held the stock for more than one year, the kid is immediately eligible for the lower tax rate. (Normally, shares held for one year or less are taxed as ordinary income.) Better yet, if the child is in the 10% or 15% income-tax bracket, he'll pay just a 5% long-term capital gains rate, compared with a 15% rate paid by those in the higher brackets. (Today, the 15% income-tax bracket ends at $29,700; this will adjust for inflation in the future.)

Keep in mind, the cost basis for the shares will be the donors' cost basis, according to Rokovich, which means that if the stock has appreciated nicely over the years, Junior might owe tax on a wide spread. (For more on this, read our story.) Still, it's about time he learned that, in the real world, few lunches are free.