Using the Roth IRA to Give the Gift of Financial Security

Help your childrenand/or grandchildren to build good financial habits by setting up andcontributing to a Roth IRA this year, and every year.

Key Takeaways

• 1 in 3 Americans have less than $5,000 saved forretirement. (CNBCAug. 2018)
• Just like eating healthy and regular exercise,the sooner one gets into the habit of saving on a regular basis, the more itbecomes just part of ones everyday activities, and the more financially secureone will be.
• The best place to start saving and investing is touse a Roth IRA account.
• Parents and/or grandparents can offer to “match”contributions, or just contribute, to a Roth IRA to help build good saving andinvesting habits.
• Contributions to a Roth IRA can be taken out ofthe Roth at any time – tax-free and penalty free. This is unique to a Rothcompared to other tax favored, retirement plans.
• You can set up a plan at a discount broker forfree and have $0 commission trading.
• Up to 100% of earned income can be contributedto a Roth, subject to limits. (See Below.)

When it comes to investing and saving for the future, one ofmy favorite sayings is that “a goldfish grows to the size of its bowl.” Whilenot actually true, the visual serves as an important lesson. It is always easy forthe goldfish to move to a larger bowl, but very difficult and uncomfortable tomove to a smaller one. Similarly, most people, upon receiving a raise or anincrease in income, simply spend more. Their lifestyle grows to the size oftheir income.

What does one have to do to save for retirement? If you saved10% of your income for retirement, from day one on your very first job, you wouldbasically be living in a smaller bowl, in that your lifestyle would besupported by 90% of your income versus 100%. The benefit of this is hard tooverstate.

First, you get in that habit of saving early and often. (Weall know the powerof compounding.) Second, if you get used to living on less money, you will subsequentlyneed less money to support your retirement. In other words, the more you save,the less you will need, allowing you to achieve financial independence sooner.

A Roth IRA is often the best retirement account option for youngearners. Although contributions are after tax, you are more likely to be in alow tax bracket early in your career. The same is less likely to be true in thefuture as your earnings increase. Unique to the Roth IRA among retirementaccounts, contributions can be withdrawn at any time free of tax and/orpenalty, for any reason. This allows the Roth IRA to serve many functions,including:

• Emergency savings account
• Saving for college or home
• Longer term investment account
• The only retirement account allowing tax-freewithdrawals of all account assets after 59 ½.

Giving the Gift of Financial Literacy

For most young workers, saving for retirement is low on thelist of financial priorities. A big misconception about the Roth IRA is that itis only for retirement. And the problem with that is that for the part-timeworking high school or college student, what little money they earn they tendto need.

This is where parents and grandparents can really help motivateand educate around the benefit of saving early for retirement and the uses of aRoth IRA. You could simply make their Roth IRA contribution for them. However,it’s a great idea to get them involved in the process of saving money. You cando this by encouraging them to make contributions and matching those contributions.Depending on the age of the child and other economic factors, a 100% to 200%match can be an excellent incentive. (Keep in mind that the child must haveearned income for the total amount of the contribution, but the contributionsdo not need to be their money.)

Example One: Sean has been working as a tutor in high school. He does not earn much, a total of $1,500 a year. The maximum that could be contributed to Sean’s Roth IRA is the $1,500. Sean’s grandparents have offered to contribute 100% of his earnings into a Roth IRA for his benefit.

Example Two: Julie works as a waitress in college. She earns $8,000 a year but needs much of that money for her expenses. Her parents want her to have “skin in the game” with respect to college, but also want her to see the value of saving for retirement. They have offered to “match” 200% of her Roth contributions. Since Julie earned over $6,000 in 2019, she can contribute up to the maximum. So Julie contributes $2,000 and her parents match another $4,000.

Example Three: Kathy has her first job out of college. She is earning $55,000 a year. Her employer offers a 401k plan, however there is no company match. Kathy’s grandmother has offered to match 50% of her contributions, if she saves at least 10% of her gross income, which is $5,500. This equates to a match of $2,750, for a total savings of  $8,250. Since the Roth maximum is $6,000, Kathy ends up saving $2,250 of her earned income into the company’s Roth 401k plan and the remaining $3,250 of her money into the Roth IRA. Her grandmother then contributes a $2,750 match into the Roth IRA.

In all of these examples, the children could withdrawal thefull amount of the Roth contributions and spend the money right away.  However, it has been our experience that thechildren don’t. They appreciate the gift and respect that it is for expensesdown the road. In fact, we find that most children do not even look to thesefunds to help with a down payment on a home, but rather view them as retirementinvestments.

The great aspect of this is that the contributions can bewithdrawn for emergencies or other purposes at any time. Not only are theparents and grandparents giving the gift of financial education and instillinga habit of saving, they are also making relatively small, annual contributions thatcan be used in the future for life’s big ticket items: graduate school, downpayment on a home, wedding, or even their own children’s college education. Andof course, retirement too.

Timing of Contributions

Contributions do not need to be made until tax day thefollowing year. For 2019 Roth IRA contributions, you have until April 15, 2020,to make the contributions into the account. So, no need to rush and do thisbefore year-end. However, over the holidays can be an excellent time to havethe conversation with your children or grandchildren.

Special Offer for Navigoe Clients

For the children and grandchildren – even nieces and nephews– of our clients at Navigoe, we can help set up the account, get them fundedand even make some investment recommendations, complimentary, as a courtesy toyou.

Roth IRA Rules

Thisretirement savings account is funded with after-tax contributions; assets growtax-free.

• Contributeup $6,000 for 2019 ($7,000 if you’re 50 or older) of earned income.
• Contributeto a Roth IRA if your adjusted gross income (AGI) is below these limits:

Tax year 2019: $193,000 if you filejointly, or $122,000 if you file as single. You can make a partial contributionif your AGI is under $203,000 (jointly) or $137,000 (single).

• Withdrawearnings tax- and penalty-free starting at age 59½, if the account isopened at least five years
• Withdraw contributionstax- and penalty-free any time
• Norequired minimum distributions (RMDs)