Leveraging the Roth IRA for a (Grand)Child Born Today

Your Newborn Child As A Middle Class Millionaire … Someday.  Part 2 of 2.

Chris Carosa (DC Insights, Fall 2017) generously shared his thoughts on his book – From Cradle to Retirement – The Child IRA – How to start a newborn on the road to comfortable retirement while still in a cozy cradle.  We discussed a number of unique concepts about long term investing in the first blog on this topic . While not directly related to 401(k)s, we believe this topic is relevant to the power of long term tax-advantaged retirement savings.

As mentioned in the prior post addressing long term investing, Ben Franklin and I share a belief in America’s future.  As a parent, I believe in a future for my children. To that end, I took steps very early in their lives to try to ensure that my children will achieve that version of the “American dream” where they are better off than their parents. Back in the 1980’s, I set up accounts registered under the Uniform Gifts to Minors Act.  (See:  http://fiduciarynews.com/2016/08/exclusive-interview-with-jack-towarnick...)  I didn’t have a lot to invest;  I invested $1,000 for each and hoped history would repeat itself with a 12%/year investment return.  

Today, you have access to a Roth Individual Retirement Account (Roth IRA).  Directly or indirectly (“back door”), every wage earner in America can contribute to a Roth IRA.  So, to engage in “long term investing” to benefit your (grand)child, an option to consider is opening a Roth IRA with the intent of providing a financial legacy (or perhaps mentally segregating money in your 401(k) or 403(b) plan).  The maximum annual contribution to a Roth IRA is $5,500 in 2017, $6,500 if you are age 50 or older.  The maximum annual contribution to a Roth 401(k) or Roth 403(b) is $18,000 in 2017, $6,000 more in catch-up.

So, if your (grand)child was born today, and if you wanted to set up a “Ben Franklin” account with a goal of ensuring she would be a middle-class millionaire … someday, you may want to consider using the Roth IRA as the vehicle.  It would be your Roth IRA with your child as the sole beneficiary.  You might adopt a goal of contributing $5,500 a year for her first seven years.  With that large of a contribution, even if the account averages only a 6% rate of return over the 60 year period, you may achieve that goal – she would be a Middle-Class Millionaire upon inheriting the account - $1,012,824 at age 60.  If you have accumulated Roth IRA or Roth 401(k) monies, the lump sum investment amount at birth (assuming a 6% return) would be $32,134 (author’s calculations). 

Why use a Roth IRA where you are the owner?  First, because your child probably has no earned income, the IRA could not be hers.  Second, the IRA accumulates earnings tax deferred.  Third, you would want to let assets accumulate until earnings qualify for Roth IRA tax-free treatment – generally, when you reach age 59 1/2.  At that point, your child might be age 30 or so.  Then, you would have a choice – take distributions and pass them to the child so she can invest them in funding her own Roth IRA, or continue to accrue earnings in your Roth IRA which she can later inherit.  

At your death, any remaining Roth IRA monies could become an Inherited IRA.  Here is where Roth has unique value.  The tax rules today work to her advantage (but, consider that Congress can always change the tax rules).  Your adult child could open an inherited IRA using the Life Expectancy Payout method – where payments are spread over her life expectancy.  So, if you died soon after the child’s birth (or if the account were established by  a grandparent or great grandparent) the payout for the child would be over ~82 years using today’s life expectancy.  If you died when the child was age 30, the payout would be over ~53 years.  This is “long term investing” – Ben Franklin style!

Note:  Many have recommended federal and state governments take similar actions - funded by taxpayers.  For example, see:

• https://csd.wustl.edu/Publications/Documents/RS16-07.pdf 
• http://www.aecf.org/resources/investing-in-tomorrow-helping-families-bui...
• https://crowley.house.gov/press-release/crowley-ellison-introduce-legisl...

However, given our annual federal and state budget deficits the money may not be there for taxpayers to fund your child’s Ben Franklin account.  So, you may not want to wait for the government to act.  

Your (grand)child, born today, will reach age 60 in 2077.  If you take action today to create a financial legacy, perhaps you’ll create a family legacy that she, herself might pass on and repeat for generations to come. 

Before taking action, always discuss your investment and financial plans with whoever helps you with financial decisions and tax decisions.

We are providing this information to you solely in our capacity as individuals with knowledge and experience in the benefits industry and not as legal or tax advice.  The issues presented here may have legal and tax implications, and we recommend discussing this matter with your legal and tax counsel prior to choosing a course of action.  This article is not (and you/others should not use it as a substitute for) legal, accounting, actuarial, or other professional advice.