One of the most important conversations I have with my clients and friends, is around the topic of Roths for their young adult children. There’s not a parent amongst us who doesn’t want their child to get off on the right foot financially; use credit responsibly, build savings into their budget from the “get go” and save for retirement earlier than they did.
Roths and Roth 401ks for our 20-something children makes a ton of sense. Why?
- Low tax brackets in their 20’s.
- Most young adults are not in a high tax bracket at this point in their lives so paying taxes on their contributions today so they never pay taxes on these dollars again seems like a great tradeoff
- Compounding is the 8th Wonder of the World (according to Einstein and he should know)
- Get the benefit of tax free growth and compounding on their contributions and the earnings year after year
- Withdrawals after 59 ½ are tax free. Let me re-state that. Withdrawals after 59 ½ are completely tax free – incredible.
- NOTE: Although original contributions can be removed sooner than 59 ½, I would not advise viewing your Roth as a short term savings vehicle. It’s a long term retirement account – leave it alone.
- No Required Minimum Distributions. Roth holders do not have to take Required Minimum Distributions at age 70 ½. That’s big!
Unfortunately, many adult children have school loans they are paying on which makes it harder to begin saving early in their careers. Some strategies below for them and/or their parents:
- Roth 401k. If you have school loans to pay, it’s tough but …
- Begin contributing something – it feels good!
- $100/month ($50/pay period) and a hypothetical 6% return/year
- over 30 years, grows to $100,451
- over 40 years, grows to $199,149
- And, most people increase their contributions as they earn more, pay off debt, etc. so this is likely modest over one’s lifetime.
- $100/month ($50/pay period) and a hypothetical 6% return/year
- Contribute up to your company’s 401k match. This is FREE money. Many companies will contribute 3% to your 401k if you contribute 6%. That means 9% is being contributed to your retirement account each year. If you can do the minimum to get the maximum match, it could be worth it to you.
- Begin contributing something – it feels good!
- Parents Match Child’s Individual Roth Contributions. I have seen parents match their children’s individual Roth contributions in order to get compounding working for them early, incentivize them and help them achieve their maximum contribution of $6,000 per year in their 20’s (assumes the child has at least $6,000 in earnings for the year). So, assuming a hypothetical 6% rate of return (not intended to represent the returns of any investment)*:
Person | Contributions | Time Period | Value at 10 years* |
Child | $250 a month | 10 years | $40,970 |
Parent | $250 a month | 10 years | $40,970 |
|
| Total Value | $81,940 |
- Scenario 1: After 10 years: Parent stops matching and young adult continues making $250/month contributions (assumes adult child does not get income phased out of making individual Roth contributions)
Person | Contributions | Value at 10 yrs* | Value at 20 yrs* | Value at 30 yrs* | Value at 40 yrs* |
Child | $250 a month | $40,972 | $115,510 | $251,129 | $497,873 |
Parent | $0 after 10 yrs | $40,972 | $ 73,371 | $131,396 | $235,311 |
| Totals | $81,944 | $188,881 | $382,525 | $733,184 |
- Scenario 2: After 10 years: Both parent and child stop making contributions
Person | Contributions | Value at 10 yrs* | Value at 20 yrs* | Value at 30 yrs* | Value at 40 yrs* |
Child | $0 after 10 yrs | $40,972 | $ 73,371 | $131,396 | $235,311 |
Parent | $0 after 10 yrs | $40,972 | $ 73,371 | $131,396 | $235,311 |
| Totals | $81,944 | $146,742 | $262,792 | $470,622 |
Einstein was right – compounding is a beautiful thing! Most of us agree that “Budgeting and Investing 101” should be taught in our schools. It’s a basic necessity for achieving and maintaining quality of life. But, if they won’t, we must. Talk to your adult children and help them see the wisdom to saving for retirement early in their careers. Compounding works but the earlier you start the better. It may also mean that you are able to save less over your life time to meet your eventual retirement goals because you got compounding working for you early.
Also, see my blog dated June 2018 https://www.kshadvisors.com/blog/back-door-roths on the merits of “Back Door” Roths. Such a strategy is helpful if you are “income phased out” of contributing to an individual Roth. And, don’t forget your company’s 401k Roth or “after tax” account which can be rolled to a Roth upon leaving your company.