Urban legend has it that financier Bernard Baruch was playing some form of 1920’s “Trivial Pursuit” in a posh Manhattan apartment. A question was posed to him—“What are the seven wonders of the modern world?” He answered, “I have no idea but I can tell you the 8th—compound interest.” A few years later, Albert Einstein was quoted as saying, “the most powerful force in the universe is compound interest.”
Today, we provide a rather offbeat post aimed at parents and grandparents. It is a ridiculously simple way of transferring substantial assets to your children and grandchildren without setting up elaborate trusts, convoluted wills, or other means that only make the lawyers money.
What I am talking about is giving your children a Roth IRA. A Roth, named after the late Delaware Senator William Roth, is an Individual Retirement Account (IRA) with a twist. If you earn less than $109,000 as a single person or $169,000 for a couple and are under 50, you can put $5,000 into a Roth IRA each year (over 50? You can ramp up to $6,000). The benefit of the Roth is that when you withdraw money from a Roth after age 59 and a half, there is no income tax due.
As a result, many parents of young adults are gifting Roth IRA’s to their children each year. They are doing their children a tremendous favor. Today, most young adults, even of affluent families, fear that they will not be as prosperous as their parents. This is the first time that this has happened in U.S. history. If a young person puts $5,000 away each year in a Roth starting at age 22, works steadily until age 65 and gets an average appreciation of 8% per year, he or she will have $1.29 million accrued. And, they can withdraw it tax-free!
Of course, not many 24 year olds have an extra five grand lying around and some lack the discipline. So many affluent, caring and imaginative parents are doing the job for them by gifting them a Roth each year. Many people of modest means do it as well. Some open an account for $1,000-1,500 and then add whatever they can afford each year. They will not give their children millions but can they help them big-time. Bernard Baruch called compound interest the 8th wonder of the modern world. I would posit that TAX-FREE COMPOUND INTEREST via a Roth IRA is even more powerful.
Some people are real visionaries about Roth’s. A man I know of but do not know personally is a retailer who puts his three-year-old granddaughter in his print ads and commercials. He pays her a salary as an actress. With real income, the apple of his eye is eligible for a Roth each year. He makes the maximum contribution each year and she will have a burgeoning next egg by the time she hits adulthood. By the time she is 60, grandpa will be long gone, but his gifts will sustain her forever.
Even some extremists are into it. One fellow wrote to me “the dollar is toast. If we keep spending recklessly, our money will be worthless in a generation. So, I buy my son a Roth each year and put it in an emerging markets mutual fund. If the US stumbles, my son will be okay.” Another gloom and doomer says, “We have to stop printing money. Each month I add to my daughter’s Roth. I keep the money in a gold share fund.” Now, I am skeptical of people who are not well diversified. But, the point is that no matter what you think about the current economic climate, you can find a way to help those whom you love with this neat trick.
You may never be a multi-millionaire yourself, but you can get your children a lot closer than you might think.
If you would like to contact Don Cole directly, you may write to him at firstname.lastname@example.org