Are you looking for a way to get your children or grandchildren introduced to saving and investing? If so, I have a strategy for you to consider. It may also help them to build a nest egg that will give them financial independence in the future, which so many baby boomers and GenXers do not have.
Offer to match whatever amount the child earns in a year – up to a set limit, perhaps $5,000 – and put the money into a Roth IRA. A Roth IRA will grow tax free and withdrawals in retirement are also tax free.
Let’s say you take this approach every year while the child is in high school and college for just half of the maximum allowed in our example, or $2,500. You would have contributed a total of $20,000 and when the recipient reaches age 65 the Roth would have grown to approximately $300,000, based on a 6% return. That’s the power of compounding. Compounding is the ability of an investment to generate earnings, which are then reinvested in order to generate their own earnings.
Hopefully watching this money accumulate will inspire your child or grandchild to continue to put money into that same Roth IRA just as soon as they start working. The goal is to build their interest in the power of saving and investing, to compete with the appeal of goodies like the fancy new car they have yearned for while in school.
To demonstrate how starting early and getting more years of compounding is powerful, look at the following numbers. Let’s say they get their first full-time job at age 23. They contribute the maximum of $5,000 to a Roth IRA for just 10 years, for a total $50,000. At age 65 the Roth would have grown to approximately $450,000, based on a 6% return. If the person procrastinated for 10 years and started their contributions at age 33, it would be necessary to contribute $5,000 every year for 27 years, a total of $135,000, to achieve the same approximate $450,000 at age 65*.
With $5,000 contributed every year from age 23 to 65, you are talking an accumulation of approximately $950,000. Add to that anything that was accomplished from your gifting to fund a Roth while they were in school, and your child or grandchild may have well over $1 million. At that point, it might be hard to keep them from finally buying goodies like that fancy new car!
What strategies do you use to help your children (or grandchildren) develop an interest in saving and investing?
*For illustrative purposes only. Investing in securities involves risk, including the potential loss of principal invested. Past performance is not a guarantee of future results.
A Roth IRA distribution is qualified if you’ve had the account for at least five years and the distribution is made after you’ve reached age 59 1/2, because of your total and permanent disability, in the event of your death, or for first-time homebuyer expenses. Distributions made prior to age 59 1/2 may be subject to a federal income tax penalty. If converting a traditional IRA to a Roth IRA, you will owe ordinary income taxes on any previously deducted traditional IRA contributions and on all earnings. We suggest that you discuss tax issues with a qualified tax advisor.