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The Gift that Keeps on Giving

| February 05, 2016

Many parents or grandparents struggle to find that “perfect” gift for a hard to please youth or young adult.  What if there was a gift that did not require you to know their size, favorite color, music tastes, doesn’t require batteries, gasoline or insurance.  Would you be interested?  Best of all it’s the gift that keeps on giving year after year. 

Surprise, it is a Roth IRA!  Did you know minors or young adults can establish a Roth IRA as soon as they start receiving an income?  Few young people do, but this is where a savvy relative can step in.  A Roth IRA can be established on a teenager’s behalf by someone who can afford to fund the account in an amount equal to the income earned by the youth, up to the contribution limit of $5,500 for year 2016. 

Here is what is important:

  1. Age:  There is no minimum age to establish a Roth IRA.  All that is required is for the child to have reportable wages.  This is called “earned income”.
  2. Equal funding:  An individual can’t contribute more than want is earned in any year.  For example, if my son earns $2,000 working part-time at Arby’s, he would be eligible to establish a Roth and fund it up to $2,000, which is his earned wage total.
  3. Funding Source:  There are no rules requiring the youth to fund the account with their own money.  In a nutshell, anyone can make the contribution.  It could be the parent, grandparent, or anyone that would be interested in helping that youth get a head start with retirement savings. 

Remember this gift gets much better over time.  First, you are educating that youth on the power of compounding.  Second, Roth assets are funded with after-tax dollars and compound tax-free.  Third, when the money comes out of the Roth, say 40 years later, the income is tax-free.  Table 1 shows the power of the Roth IRA strategy and the value of compounding over time.  Let’s say you set up a Roth for your wage-earning child and decide to help them fund it for 10 years (age 15-24) at $2,000 per year.  After 10 years, you stop funding the account.  The Roth in this example stays invested for 40 years, growing at 8%.  At age 64 the account would be worth $629,427!  If you are lucky enough to still be around, your child might remember to send you a thank you note. 

Roth Savings Table

Notice the power of 10 extra years.  If the funding plan began 10 years later (age 25) the difference is shocking. 

When it comes to creating wealth, investors have many tools to use.  The Roth IRA is one of those tools that when used properly, has the potential to build a mighty retirement asset. 

The Bottom Line:  The earlier you start a savings strategy, the more time you have to take advantage of the power of compounding.  This is true if we are talking about a Roth IRA, 401(k), or any other valuable investing tool.  Today we shared an idea on how you can help a young investor get started building a portfolio.  All investors need to put thought toward their risk tolerance, time horizons, and accumulation goals when choosing appropriate strategies to help build a nest egg.  We help individuals, couples, professionals and business owners build customized investment strategies.  If you have questions, we are as close as the nearest telephone.



Written by Phil E. Gose

Capital Resource Management, LLC