If you contribute $5,000 a year to a Roth IRA in your child’s name from the time he starts mowing lawns or she starts babysitting at the age of 12 through college, your child will amass $6.1 million dollars when he or she retires at age 65 (assuming 10% annual growth). Sound too good to be true? It’s not. Here’s how to make your child rich:
Open a Roth IRA for your kid as soon as they start earning an income. The income part is the linchpin. They must have an earned income in order to qualify for a Roth IRA. Allowance, birthday money from grandma, and savings account interest does not count.
A W-2 form would help ease the IRS’s worries about their earned income requirement, but it is not mandatory. If you keep good records of all your children’s lawn mowing and babysitting gigs, that will be good enough for Uncle Sam. It would also look better if a majority of their jobs were not at your home. Get them to mow the neighbors’ yards and watch the neighborhood kids instead of just your yard and their siblings. You can contribute an amount equal to 100% of what they earned for the year or the Roth IRA maximum contribution level of $5,000 per year.
Not only is the interest and capital gains tax free for minors who own Roth IRAs just like it is adults, but many minors’ incomes are not taxed at all because their small earnings are below the standard deduction. So, minors using this plan will pay negligible taxes on their earned income and their investments will also grow tax free in a Roth IRA. It is almost like having the best of a 401-k and Roth IRA plan all wrapped up into one deal.
Time is of the essence though! This plan relies on compounding interest. Your kids’ investments will grow beyond your wildest dreams the sooner you start. $5,000 invested per year earning 8% interest annually from the age of 12 to 18 (just seven years) will grow to almost $1.8 million tax free by the age of 65 or $830,000 at age 55 if they wanted to retire early. But, if you waited to start contributing to a Roth IRA until your child was 18 years old and maxed out a Roth for the next seven years and contributed nothing more, your son or daughter would only accumulate $1.1 million by the time they retired at 65 years old. The power of compounding is magnified by the age that you start investing. The sooner you can begin investing for your children, the better their retirement nest egg will be. How great a gift would this be if you could give your children a secure retirement with as little as $35,000 invested over seven years when they were just teenagers?
Don’t believe me? That’s okay. Check my math with this Microsoft Excel spreadsheet in our resource section where you can change the assumptions and see the results for yourself.