Roth IRAs for Kids: Half-Century of Compounding

According to Fidelity, 61% of children growing up in households with annual income above $250,000 have a Roth IRA. Sometimes, we have conversations in broader society about the privileges and benefits that accompany being born into wealth, but often the discussion only occurs in a general sense without the pin-pointing of specifics. Well, here’s your specific.

We probably live in a world where I would guess a majority of Americans do not understand what an individual retirement account is. I would guess that maybe a quarter of Americans could tell you that the IRA annual contribution limit is $6,000 or $7,000 if you are over the age of 50.

That is not how America’s wealthy operate. They know that they need to get their kid’s a job, even if is something trivial, so that they can meet the income requirements to fully fund the Roth IRA (they know that the Tax Cut and Jobs Act of 2018 contains a provision that explicitly allows parents to pay children up to $12,000 per year for household cleaning and related chores) for their children.

Being a kid with a Roth IRA that is fully funded is a game-changer for life. It’s a singular decision that basically gives kids a built-in pension plan that could single-handedly fund a retirement even if the rest of their life proves unremarkable from a wealth generation standpoint. Fully funding a Roth IRA for a kid from age 12 through 18, will result in a $42,000 funded accumulation of capital contributions that will grow to over $3 million if held until age 68 in a plain vanilla S&P 500 Index Fund that earns 8.25% annual returns over the long haul.

The entire working career could be squandered with no other source of wealth created in one’s life and that would be enough for a retirement spent collecting $100,000+ in annual income without touching the principal. A few thousand dollars, put into a tax-advantaged account for a child, and then never disturbed, essentially gives the kid a functional equivalent of a high pension.

And plus, my gosh, the tax protection. Creditors cannot touch individual retirement accounts. If you file for bankruptcy, individual retirement accounts are protected under provision 11 U.S.C. 522(n) up to $1,362,800. Note: If you try to look up the Code yourself, you may only see protection up to $1,000,000, but the figure is indexed to inflation every three years, and the 2019 inflation adjustment took the protection amount up to $1,362,800. By the time the account crosses this threshold, the index inflation adjustments could well have risen to protect all or at least even more of it.

As long as the kid is successfully trained to never touch the IRA contribution until his retirement age, a financially successful retirement is self-propelling in the background as he goes through life.

Better yet, retirement account contributions are not part of the FAFSA calculations for college aid (though the income earned above $6,400 does affect financial aid, so the wealthy optimize their teenager’s annual income to be at least $6,000 to get the full Roth IRA contributions but less than $6,400 so as not to affect college aid to the extent they may be eligible since some colleges surprisingly do not cut off aid until the household income crosses $300,000).

The encouraging part of the story is that these opportunities are available to anyone. As a teenager, I once made $8,500 in a summer umpiring baseball games. The cost was that I had to work Friday at 6 pm and Saturday morning at 8 am, but hey, that’s life. Making $6,000 in a summer is not some impossible task. If you got the work ethic, you can make it happen. From there, it’s having the knowledge to open up a Roth IRA, acquire some great stocks or an index of great stocks, and then let the compounding engine work in the background of your life. It’s a specific opportunity that requires a little bit of capital and a lot of patience to yield a life-changing outcome.

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