Me and my youngest son on the beach in Carmel
Many people would like to leave a legacy to the children or grandchildren but aren't quite sure how to do it, they don't know the best way to go about doing it, or might not have a substantial amount of money set aside to be able to feel like they can make an impact.
There is a novel solution we've come up with that provides several key benefits:
So what is this strategy?
Custodial Roth IRA Account
Let's break down what this account actually is. "Custodial" means it's an account for a minor. So when the minor turns 18 (or the age of consent in your state), the account automatically becomes theirs and they have complete control of the account. Up until that point, the person who set up the account controls it.
And now the last part of the name, the "Roth IRA" is just like a regular Roth IRA which allows up to $6,000 to be contributed into the account on a yearly basis (as of 2020). The money goes into the account after tax, grows tax deferred, and comes out tax free. A Win/Win.
So why is this such a great strategy?
Let's use an example to show case some of the many benefits and power of using this type of account for a minor.
Let's say your 13 year daughter or son has a part-time job and has what the IRS calls "Earned Income," with Earned Income, they or you can contribute up to 100% of their Earned Income that year into a Custodial Roth IRA Account. The part-time job could be from baby-sitting, mowing lawns, painting, office work, etc. The contribution into the Custodial Roth IRA Account must be equal or less than your child's Earned Income in that year and if your child earned less than $12,000 no tax return is required to be filed. That's always a Win.
So back to our example: let's say your 13 year old child makes $2,000 per year from age 13 through age 17 (5 years) for a total of $10,000. You as a parent, or even a grandparent, can contribute that same amount into a Custodial Roth IRA Account you set up for them each year ($2,000 per year for 5 years) for a total of $10,000.
And so here's where it gets exciting. Because you/they are starting to save and invest at such a young age the power of compounding becomes unbelievably powerful. Assuming they have $10,000 in their account at age 18 and invest the money for long-term growth, it's not completely unreasonable that the account could grow at an annualized rate of 10% (the stock market historical average). If they didn't touch this money until they retired at age 65 (which is what this was intended for), the $10,000 would grow to $1,078,266. And not only this but there will be no taxes due ever. So when your child/grandchild retires, the money they pull out will not be taxed! This is a triple Win/Win/Win.
Now imagine what the account value might become if your child/grandchild started contributing to this same account when they started working. With a modest savings of just $200 a month, the account could be worth several million dollars ($3M+) by the time they retire. Imagine the piece of mind you and your child/grandchild will feel knowing their financial future is secure - all by the age of 18.
This is also a great way to teach and have fun conversations about saving, investing, analyzing companies, the economy, etc., over the course of a lifetime with your family. Engaging your children/grandchildren in the process will pay huge dividends on so many levels.
Now go open up a Custodial Roth IRA. Do it now. If you need help, send an email or drop us a line and we can discuss this and other strategies to help you and your family build wealth.
Paul R. Rossi, CFA