The Navigoe Blog

Using the Roth IRA to Give the Gift of Financial Security

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

Key Takeaways

  • 1 in 3 Americans have less than $5,000 saved for retirement. (CNBC Aug. 2018)
  • Just like eating healthy and regular exercise, the sooner one gets into the habit of saving on a regular basis, the more it becomes just part of ones everyday activities, and the more financially secure one will be.
  • The best place to start saving and investing is to use 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 and investing habits.
  • Contributions to a Roth IRA can be taken out of the Roth at any time – tax-free and penalty free. This is unique to a Roth compared to other tax favored, retirement plans.
  • You can set up a plan at a discount broker for free and have $0 commission trading.
  • Up to 100% of earned income can be contributed to a Roth, subject to limits. (See Below.)

When it comes to investing and saving for the future, one of my favorite sayings is that “a goldfish grows to the size of its bowl.” While not actually true, the visual serves as an important lesson. It is always easy for the goldfish to move to a larger bowl, but very difficult and uncomfortable to move to a smaller one. Similarly, most people, upon receiving a raise or an increase in income, simply spend more. Their lifestyle grows to the size of their income.

What does one have to do to save for retirement? If you saved 10% of your income for retirement, from day one on your very first job, you would basically be living in a smaller bowl, in that your lifestyle would be supported by 90% of your income versus 100%. The benefit of this is hard to overstate.

First, you get in that habit of saving early and often. (We all know the power of compounding.) Second, if you get used to living on less money, you will subsequently need 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 young earners. Although contributions are after tax, you are more likely to be in a low tax bracket early in your career. The same is less likely to be true in the future as your earnings increase. Unique to the Roth IRA among retirement accounts, contributions can be withdrawn at any time free of tax and/or penalty, 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-free withdrawals of all account assets after 59 ½.

Giving the Gift of Financial Literacy

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

This is where parents and grandparents can really help motivate and educate around the benefit of saving early for retirement and the uses of a Roth 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 can do 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 have earned income for the total amount of the contribution, but the contributions do 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 the full amount of the Roth contributions and spend the money right away.  However, it has been our experience that the children don’t. They appreciate the gift and respect that it is for expenses down the road. In fact, we find that most children do not even look to these funds to help with a down payment on a home, but rather view them as retirement investments.

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

Timing of Contributions

Contributions do not need to be made until tax day the following 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 this before year-end. However, over the holidays can be an excellent time to have the 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 funded and even make some investment recommendations, complimentary, as a courtesy to you.

Roth IRA Rules

This retirement savings account is funded with after-tax contributions; assets grow tax-free.

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

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

  • Withdraw earnings tax- and penalty-free starting at age 59½, if the account is opened at least five years
  • Withdraw contributions tax- and penalty-free any time
  • No required minimum distributions (RMDs)

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