I want to share a strategy that can help your children get a huge jump start on their retirement. Many clients I work with wish they’d started saving at a much younger age, and they worry their children may make the same mistakes. So, many of them hope to teach their children how to manage their own money.
One of the most important lessons to teach is how important it is to save. Most people don’t realize how much they need to save for retirement. For instance, using a common 4% sustainable withdrawal rate in retirement, you’d need to save $1 million by retirement in order to have $40,000 of sustainable annual income in retirement.
That savings goal can feel pretty daunting, especially for younger people. But the biggest advantage young people have when it comes to retirement is that they have a lot of time for their savings to grow. The earlier they start saving and investing, the more wealth they’ll build.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
But let’s get real… I’ve yet to meet the teen who is thinking about their retirement. A simple strategy that parents can implement to jump start their children’s retirement savings is to help them fund a Roth IRA.
Say your kid earns $3,000 from a job in 2023. If the income is W-2, they can contribute 100% of their earned income up to $6,500 to a Roth IRA, or $3,000. If income is 1099, the contribution limit is reduced by 7.65% (half of the self-employment tax) or $229.50 and can contribute $2,770.50 to the Roth IRA.
They probably won’t have the cash to make contributions themselves (even if they wanted to), but this is where parents can step in by giving them a tax-free cash gift (up to $17,000 per person for 2023) that can be used to fund the Roth IRA. In most states, if the child is a minor, you’d have to start with a minor Roth IRA where the parent is the custodian of the account, and then you can convert the account to a regular Roth IRA owned by the child once they are legally an adult.
How big an impact can this have on your kids’ lives? Assume they contribute $3,000 a year as a high school junior and senior, and $6,000 a year during all four years of college (so $30,000 in total contributions). If they earn a 6.8% annual return from ages 16 to 40, 6.4% from ages 41 to 60 and 6.1% after age 60 (the expected returns from 80% stock, 70% stock and 60% stock allocations, respectively), they’d have more than $600,000 of tax-free retirement savings by age 65, which could yield more than $21,000 of sustainable tax-free income throughout retirement.
* For simplicity, invested accounts assume following: 80% stock allocation from ages 16 to 40 earning 6.8% annually net of fees, 70% stock allocation from ages 41-60 earning 6.4% annually net of fees, 60% stock allocation after age 60 earning 6.1% annually net of fees. All numbers shown are in future dollars and net of 1% advisory fee. ** Sustainable annual retirement income assumes 4% annual withdrawal rate.
In addition, this creates an opportunity to teach your kids some basic investing concepts, such as what retirement accounts are and the time value of money. Hopefully, they’ll become accustomed to the annual contributions and carry those good habits forward into their adult lives.
That’s a legacy you can be proud of.
related content
- 2 Ways Retirees Can Defuse a Tax Bomb (It’s Not Too Late!)
- Will Your Kids Inherit a Tax Bomb from You?
- Four Ways Parents Can Help Kids Be First-Time Home Buyers
- Leaving an Inheritance? Is It Better to Give to Kids Now or Later?
- Should You Help Out Your Adult Kids Financially?
-
Cord Cutting Could Help You Save Over $10,000 in 10 YearsHow cutting the cord can save you money and how those savings can grow over time.
-
The '8-Year Rule of Social Security' — A Retirement RuleThe '8-Year Rule of Social Security' holds that it's best to be like Ike — Eisenhower, that is. The five-star General knew a thing or two about good timing.
-
You Were Planning to Retire This Year: Should You Go Ahead?If the economic climate is making you doubt whether you should retire this year, these three questions will help you make up your mind.
-
Are You Owed Money Thanks to the SSFA? You Might Need to Do Something to Get ItThe Social Security Fairness Act removed restrictions on benefits for people with government pensions. If you're one of them, don't leave money on the table. Here's how you can be proactive in claiming what you're due.
-
From Wills to Wishes: An Expert Guide to Your Estate Planning PlaybookConsider supplementing your traditional legal documents with this essential road map to guide your loved ones through the emotional and logistical details that will follow your loss.
-
Your Home + Your IRA = Your Long-Term Care SolutionIf you're worried that long-term care costs will drain your retirement savings, consider a personalized retirement plan that could solve your problem.
-
I'm a Financial Planner: Retirees Should Never Do These Four Things in a RecessionRecessions are scary business, especially for retirees. They can scare even the most prepared folks into making bad moves — like these.
-
A Retirement Planner's Advice for Taking the Guesswork Out of Income PlanningOnce you've saved for retirement, you'll need your nest egg to support you for as many as 30 years. For that, you need a clear income strategy, not guesswork.
-
Why Smart Retirees Are Ditching Traditional Financial PlansFinancial plans based purely on growth, like the 60/40 portfolio, are built for a different era. Today’s retirees need plans based on real-life risks and goals and that feature these four elements.
-
To My Small Business: Well, I've Been Afraid of Changin', 'Cause I've Built My Life Around YouWhile thinking about succession planning might feel like anticipating a landslide (here's to you, Fleetwood Mac), there are strategies you can implement to manage the uncertainty and the transition.
