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A 50-Year Plan for Retirement Savings

Contributing to your grandchild's Roth IRA could be a do-it-yourself solution to the impending Social Security crisis.

Ric Edelman likes to think big. He founded a nationwide financial-planning firm. He hosts a weekly radio show. He has written several best-selling books on managing money. He’s ubiquitous on PBS with shows such as The Truth About Retirement. And, in his spare time, he has crafted a plan to solve the impending Social Security crisis. It’s simple, he says, thanks to the powerful force of compound interest.

Here’s the plan. For every baby born in the U.S., the government sets up an account and seeds it with $7,000. A blue-ribbon panel invests the money in a diversified portfolio that earns an average annual return of 7.68% (the average projected return of the nation’s public pension plans). After 35 years, the original $7,000, adjusted for inflation, is returned to the government so that the program becomes self-sustaining, funding accounts for future newborns. The balance continues to grow until the account holder reaches age 70.

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At that point, an individual’s account will hold almost $1 million, which will be enough to generate a retirement benefit of $73,000 a year (today’s average Social Security benefit adjusted for 70 years of inflation) for 23 years. Edelman believes enough beneficiaries would die before age 93 to fund additional benefits for those who live longer.

At the current payroll-tax rate of 12.4%, Edelman figures a typical worker pays about $600,000 into Social Security between ages 22 and 70. He claims a single, $7,000 investment at birth could provide similar retirement income. The total cost to the government over the first 35 years would be just under $1 trillion (assuming about 4 million newborns a year). That’s a tiny fraction, he argues, of the cost of other plans that call for higher taxes or benefit cuts to make Social Security sustainable over the long term.

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Edelman’s plan wouldn’t replace Social Security right away. And he readily admits that he hasn’t dotted all the i’s or crossed all the t’s. He’s trying to bring a new idea to the table by shining a bright light on the tremendous power of long-term compounding. He got the idea from a caller to his radio show who wanted to invest for an infant grandchild’s retirement.

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As the graphic below shows, setting aside $5,000 for an infant and letting it grow for a couple of decades produces enough cash to pay for some college bills. Over a relatively short time period, compounding is okay, but it doesn’t blow you away. It’s in the way-out years that it really struts its stuff. That’s the key to Edelman’s Social Security solution.

Do-It-Yourself Plan

We won’t hold our breath for lawmakers to take up this plan to solve Social Security, but Edelman’s big thinking gives us another chance to remind grandparents of an existing opportunity to help provide for their grandkids’ retirement. We call it the kid IRA, and we wrote about it last month. It involves a parent or grandparent setting aside money in the child’s Roth IRA.

The fly in the ointment is that the child must have earned income to have an IRA, so unless the infant stars in diaper commercials, it’s tough to cash in on 70 years of compounding. But 50 years is possible, and you’d be surprised at how powerfully that can pay off.

Imagine that your granddaughter makes at least $4,000 a year from age 15 through 19 with after-school work and summer jobs and that you give her $4,000 for each of those five years to invest in a Roth IRA. (She can’t contribute more than she earns.) After age 19, no additional contributions are made.

If the money earns an average annual return of 8% and she doesn’t touch it for 50 years until she turns 70, the Roth will hold more than $1.1 million.

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