A Unique and Special Gift for a Child - The Roth IRA

Jim Moore, CPA, Principal (Sep, 2020)

A Roth Individual Retirement Account (Roth IRA) is a tax-advantaged vehicle used for long-term investment and retirement savings. In general, any earnings and appreciation accrued with respect to these accounts will be tax-free forever.

The tax-free nature of the Roth IRA, along with the ability to make annual contributions under current law equal to the lesser of compensation or $6,000, makes it a very powerful savings tool for the young adult.

We all know that one of the keys to a successful retirement plan is to start saving early. So why not open up a Roth IRA for a child or grandchild when they have their first summer job. You can open up an account in their name, and then sit down with them to explain the benefit of the Roth IRA and that you are gifting them money to open this important savings tool for their retirement. You could also discuss that as they look ahead to college and the beginning of their careers, they should continue annual contributions to the Roth IRA as well as any retirement plans offered by a future employer, such as a 401(k) plan. Finally, stress that their decisions in the early part of their working career with respect to long-term savings will have a direct impact on their financial planning and retirement decisions later in life.

Can this discussion and use of the Roth IRA as an educational tool for retirement work? Let me share my own personal experience.

My son had his first summer job at age 16 and earned $1,800. I opened a Roth IRA account in his name. We then sat down to discuss the purpose of a Roth IRA, and I told him I was gifting a contribution into this account to help start his retirement nest egg. To help him further understand the importance of this gift, I explained to him that if he were to invest $1,800 for a period of 34 years until age 50, he would accumulate $308,370 assuming an 8% investment return. This illustration certainly got his attention.

Then I showed him the results if he contributed the maximum contribution amount, which assuming the same 8% return, resulted in an account value at age 50 of $1,099,492.  He was amazed and stunned by the results. I told him this illustrates the power of tax-free compounding of savings beginning at an early age. Fourteen years have now passed, and it is rewarding to see that our conversation years ago has served as a foundation for a growing retirement plan that has prompted annual Roth IRA contributions, as well as maximizing contributions to his employer-provided retirement plan.

There are questions regarding the future of social security benefits along with many other economic challenges and uncertainties in our world today. One of the more important responsibilities we may have is to educate and encourage our children to start a tax-advantaged savings account early in their working careers,  The use of the Roth IRA, coupled with your gifts to help get them started, might just be one of the most unique, powerful and memorable gifts you could make to your child.

For more information regarding Roth IRAs, contact our Tax Principal Jim Moore at Dermody, Burke & Brown, CPAs.

 

The information reflected in this article was current at the time of publication.  This article will not be modified or updated for any subsequent tax law changes, if any.

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