Saving early on has some obvious advantages — and some larger lessons for life in general.
For example: How great is compound interest? If you make a one-time, $6,000 contribution to an Individual Retirement Account (IRA) when your child is 15, it will grow to $176,000 by the time they’re 65. (Assuming a 7% interest rate.) If the same child waited until they were 35 to make a first contribution, the seed amount would have to be $23,000 instead of $6,000 in order to get the same payoff.
Just to review, there are two types of IRAs:
- Traditional IRA: In a traditional IRA, contributions are tax-deductible but distributions are taxed.
- Roth IRA: Contributions are taxed, but money grows tax-free and distributions are not taxed.
Regardless of IRA type, if your child is under 18, you become the custodian of the account. That means you control the assets and make all the decisions — all while the account is officially under your child’s name.
As far as raising the seed money and getting it into the target account — in a tax-friendly way — some ideas are better than others. Besides garage sales, Facebook sales, and other effort-heavy ways to raise seed money, you can ask relatives to make contributions to the account in lieu of holiday gifts.
Sometimes people who own businesses are tempted to hire their kids and pay them $500 an hour. I always advise against any sort of attempt to trick the IRS — they weren’t born yesterday.
Setting your child up for success at an early age is just as important as making sure they’re well fed — financial illiteracy just happens to be easier to ignore. A lot of people find that having a third party — a financial concierge or lifestyle concierge — is invaluable for keeping them focused on things that they are prone to forget.
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