Roth IRAs: The Gift that Keeps on Giving

It’s the Christmas season… a time for giving! What better time to give the ultimate evergreen gift to the precious youngsters in your life - to create Roth IRAs by offering to make the annual contribution or to match contributions?

You may recall my August 2019 blog titled “Hypothetical Henry” in which we discussed the benefits of establishing a 529 account for the educational benefit of children and grandchildren. In that blog, I also mentioned that a youngster with earned income might consider opening a Roth IRA retirement fund. Then again, the kid might prefer to utilize that earned income in ways other than for IRA contributions (yah think?). Well, Gramps, it’s the Christmas season… a time for giving. What better opportunity to discuss the subject with your “employed” grandkids… to create Roth IRAs by offering to make the annual contribution or to match any contributions the kid(s) make. Who knows? This benevolence just might gain their short-term awareness despite its long-term implications.

Of course, your total contribution can't exceed a given grandkid’s earned income – or the tightfisted IRS’s annual limit, whichever is smaller ($6,000 in 2019 and also in 2020). In any event, Gramps might consider “matching” up to his grandkid’s earned income amount, effectively making the IRA contribution himself (i.e., if the grandchild earns $6,000 at a qualifying summer job, Gramps can offer to let the grandkid spend his or her money on other things while Gramps contributes a portion or all of the $6,000 IRA contribution limit using his own funds). The IRS doesn’t give a hoot who makes the contribution so long as it doesn’t exceed the child’s qualifying earned income for the year. By the way, those matches are additive to Gramps’s annual gift exclusion limits.

A Grandparent’s Objective

WynnSights' objective is to incentivize grandkids to start saving and investing for the long-term while still young. In short, to develop the discipline to “save and invest early and often”. The ultimate reward can be huge. And Gramps, if you’re able, contribute the total allowable amount. If not able, be as generous as possible with your match. For example, if the grandkid has $6,000 in earned income but only wishes to contribute $2,000 to a Roth, Gramps can match the grandkid’s contribution 2:1 and still stay within the child’s earned income limit and those restrictive IRS rules.

Watch That Money Tree Grow

Although saving for retirement is likely the last thing on a youngster’s mind, most grandkids will find it intriguing that a small investment today can grow into a rather sizable nest egg later. Without instruction, grandchildren might not immediately understand the concepts behind compounding, but they will likely appreciate the fact that their Roth IRA balance is growing. It never hurts to provide examples of the Amazing Power of Compounding – how even small contributions can mushroom into large numbers over time.

One tight-fisted Grandpa I know contributes $2,000 per year to each of his kids and grandkid (for 25 years in the specific case of the oldest). Let’s assume in the oldest child’s case, that the $2,000 per annum has earned 7% per year compounded annually to date and will continue to do so for another 20 years. What will it be worth at the end of 45-year period (assuming Gramps hangs around those last 20 years)? A cool $693,000 before inflation… not a bad series of Christmas gifts from the old dude. By the way, since a Roth IRA is a retirement account, income levels could affect contribution amounts along the way. Teenagers aren’t likely to reach those high-income thresholds early on, but later in life they might.

Other Pluses

Aside from watching the money tree grow, Roth IRA earnings over the long-term will never be taxable, Roth assets are protected from creditors with a few narrow state-specific exceptions, there are no RMDs (required minimum distributions) later in life, and those “compounding” benefits associated with early contributions can be substantial at retirement. These pluses, of course, assume that Congress keeps its mitts off existing IRA rules and regulations during future legislative sessions.

Current legislation zipping through Congress concerning the future of the “stretch IRA” has massive support (the existing IRA strategy permits non-spouse beneficiaries to “stretch” out RMDs based on their remaining life expectancy after inheriting the IRA, which extends the life of the IRA by continued, tax-deferred growth even after the death of the original owner. The younger the inheriting beneficiary, the lower the RMD, which means more assets remain in the account sheltered from taxes). Eliminating the “stretch IRA” would mean a higher tax bill for non-spouse beneficiaries; thus, the massive Congressional support.

Caveat: Those Darn Minuses

By the way, when an adult opens an IRA account for a minor, it must be in the child’s name as well as in the name of the adult custodian (parent, grandparent or guardian), which introduces certain disadvantages and risks. At age 18 that child or grandchild would gain full control of the Roth IRA and might decide to…shall we say…dip into it. Should such early withdrawals occur, the cumulative annual contributions can be withdrawn first with no tax or penalty. After that, all subsequent investment gains withdrawn would be taxable to the child or grandchild, and subject to early withdrawal penalties if they don’t meet certain IRS “qualified distribution” standards.

In Summary

Aside from those previously mentioned pluses, the value of teaching your children and grandchildren the importance of saving, the basics of investing, and the discipline to leave a quality portfolio (think low-cost, highly diversified index funds) undisturbed until retirement cannot be overstated. What better way to contribute to your progeny’s future financial well-being than by creating and donating to their very own Roth IRA – accompanied with the reasons why you’re doing it.

As I’ve mentioned in prior blogs, according to that gifted intellect, Albert Einstein, the greatest invention in human history was… you guessed it… compound interest. Try it on for size!