Something You Can Do For the Kids

Do you ever wonder if there is something you can do now to help ensure a richer life for your children (or grandchildren)? Here is a powerful suggestion.

The Roth IRA is a remarkable vehicle for saving and legitimate tax avoidance — arguably one of the greatest retirement tax breaks ever created. It works like this: Investments made inside a Roth IRA are free to grow and are not taxed when they are taken out of the Roth account (subject to some rules and restrictions, the main one being that you not take the money out until age 59 1/2 or later).

That all growth on the original investment is tax free sounds almost too good to be true. Some members of Congress thought so as well, and the law includes significant limits on how much of this good deal each person may take advantage of annually. For year 2015, an individual may contribute no more than $5,500 ($6,500 if over 50 years old). Furthermore, there are limitations designed to deny this wildly generous arrangement to high earners. An individual whose adjusted gross income for 2015 is over $131,000 is not eligible to contribute to a Roth IRA this year. (For a married couple, that AGI number is $193,000.)

One more limitation on Roth-IRA eligibility must be mentioned. This retirement account is about “earned income” and nobody is allowed to contribute more than they made from work in any given year. Thus, even a person with significant income from investments, social security, pensions, etc. could not contribute unless he had W-2 forms (or equivalent) showing earnings.

How is all this relevant to helping your children or grandchildren? If a kid has 2015 earnings from work (such as a summer job), he or she may be eligible to contribute to a Roth IRA this year. The problem, of course, is that no teenager we have ever met is going to sink those earnings into a retirement account. Their motivation for summer or part-time work is to meet a hundred more immediate uses for the money. And they intend to spend it on exactly those desires.

This is where you come in. By offering to effectively “match” the kid’s earnings by funding their Roth IRA at least partly out of your own pocket, you can create the best of all possible worlds. The summer earnings are available for spending and the Roth IRA gets funded to the maximum amount allowable. As an added bonus, you may begin to instill the world’s most important financial habits: saving and investing regularly and intelligently.
To say that “someday he will thank you” is an understatement. The very long time frame between now and your teenager’s retirement allows for two amazing things to happen. Money within the account can be invested in the asset class expected to bring the highest return over long periods. And the magic of compounding is free to do its remarkable thing.

Here is an example that I hope will motivate you: Your 19-year-old granddaughter makes a one-time contribution of $5,000 into a Roth IRA, half from her own money and half contributed by you. The investment, on average, earns 9 percent per year. At age 71, she finds that the account has a value of $441,720.85. Make this investment for three years in a row and the value at age 71 would exceed a million dollars. And because it is in a Roth IRA, the money is not taxed upon withdrawal.

It is hard to believe that such a straightforward action in the present could have such a big impact on the financial future of the children and grandchildren you love so much. Believe it. And do it.