This is another post on the theme that the tax code is the biggest source of financial returns.
Let's talk about Custodial Roth IRAs. They are easy to open and manage. To have one, your child (or grandchild, niece, nephew or other child you care about) needs to have earned income. However, you, as the adult, need to open the account as custodian. When they turn 18 (or 21 in some states), you hand it off to them. Obviously, to earn money, they need to be old enough to reasonably hold that job.
I was curious to see how much such an account could be worth, so I did some quick math:
The child gets a job making $6,500 at age 12. That is the maximum contribution to a Roth IRA.
I assumed contribution limits go up by $500 every other year - not unreasonable considering recent history.
That is a total of $50,000 contributed over seven years (until child turns 18).
I assumed no further contributions. Of course, if they have earned income during their college and post-college years (below limits), they can continue to contribute to the same account.
I assumed a 6% return on investments, adjusted for inflation - again, not unreasonable.
By the time they turn 67, your child will have just over $1M. In today's dollars!
And the best part? All that money can be withdrawn tax-free.
Some caveats and nuances:
You can contribute to the account if your child chose to spend some or all of that money. For example, if your child earned $1000, but chose to spend $500, you can add $500 to their account on their behalf.
Make sure the child doesn't have multiple Roth IRAs and exceed their contribution limits.
One potential risk is that the child may, as an adult, choose to "raid" their Roth IRA. This is difficult to police, but hopefully, you have taught them better. Contributions (the $50k we put in) come out tax-free, but the earned balance comes out taxed and penalized.
Like all great financial planning strategies, this idea combines a good work-ethic, frugality, investment, patience and compounded returns. And the only contribution you will have made to this "gift" is your initiative and guidance in your child's early years.
What are you waiting for?
This material is intended to be of general interest, not personal financial advice or a recommendation to buy, sell or hold any security or adopt a particular investment strategy. Your circumstances and attitudes toward risk matter, and only an advisor working with you can give you specific advice. All investments carry the risk of loss, including loss of principal. Stock and bond prices can be volatile. Past performance is not an indicator or guarantee of future results. Diversification does not guarantee profit or protect against risk of loss. This material may not be reproduced, distributed or published without prior written permission from Sanjay Pamurthy/Artham Advisors LLC. Data from third party sources quoted here has not independently verified, validated or audited. Although information has been obtained from sources that Artham believes to be reliable, no guarantee can be given as to its accuracy and such information may be incomplete or condensed and may be subject to change at any time without notice. Artham accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user.
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