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Millionaires are certainty in the news.
There’s a recent book called Secrets of the Millionaire Mind about
how millionaires think and act and the television game show Who
Wants To Be a Millionaire? remains popular. For many people,
becoming a millionaire sounds like a pipedream, but it is possible,
especially for young adults with time on their side. Even young
children can start on the path to future wealth.
It is possible for a child to become a
millionaire, indeed a multi-millionaire, by investing in an
individual retirement account (IRA) at an early age. The magic of
compound interest over five decades (e.g., age 15 through age 65) is
positively awesome and can turn even small regular deposits into a
substantial nest egg for retirement. The only “catch” is that
children, like all IRA depositors, must have earned income from a
job or self-employment. Gifts and allowances don’t count. Children
can make an annual IRA contribution of up to $4,000 (@007 figure) or
the amount of their annual earnings, whichever is less.
In addition to paid employment, many
children earn cash payments from activities such as lawn mowing, car
washing, newspaper routes, and babysitting. Keeping a simple log of
the date and payment for these activities (e.g., April 30, lawn
mowing for Mrs. Smith, $25) is recommended to provide proof of
earned income in the event of an audit. So-called “Head Start IRAs”
can begin as soon as a child has received any sort of income,
perhaps as early as age 10 or 12. If parents own a business,
opportunities to hire their children may also be available (note: be
sure to pay a reasonable wage to avoid IRS scrutiny).
The reality, of course, is that most
children who struggle to earn $500 or $1,000 over the course of year
aren’t about to lock up their hard-earned money in an IRA for 50
years. That’s okay. Their parents, grandparents, or other benefactor
can fund an IRA to the extent of a child’s earnings. For example, if
17-year old Susan earns $1,000 and has other plans for her money,
her grandfather could put up to $1,000 in an IRA in Susan’s name.
The growth of an IRA over five
decades is phenomenal. Below are several examples. If a teen (or
someone on their behalf) contributed $2,000 to an IRA for just five
years from age 14 through 18, and never contributed another cent,
they’d have almost $1.2 million at age 65. If an even younger child
contributed $500 at age 8, $750 at age 9, $1,000 at age 10, $1,250
at age 11, $1,500 at age 12, and $1,750 at age 13, and $2,000
annually from age 14 to age 65, they would have over $4.2 million.
These examples assume a 10% average annual return.
Here are two final thoughts about
long-term IRA investing.
First, children should unquestionably
fund a Roth IRA. Tax deductions are of little consequence at an
early age compared to the appeal of tax-free withdrawals of money
that will accumulate over 50 years. Earnings from traditional IRAs,
on the other hand, would be fully taxable at a child’s retirement
age tax bracket upon withdrawal.
Second, the impact of earning a
higher return (e.g., 8% instead of 5%) and paying lower investment
expenses over time should not be underestimated. A long time frame,
attractive investment yields, and low expenses (e.g., a 0.20%
expense ratio on a stock index fund) provide young investors with a
priceless advantage: the potential for financial independence. |
