Many parents and grandparents have discovered that one of the secrets to teaching kids about money is giving them a chance to handle it responsibly, which includes saving a portion and watching it grow. The magic of compounding, if learned early in life, can impress upon even the very young that money is something that can actually work for you, rather than the other way around.
Roth IRAs are actually a great vehicle to drive home this vital lesson, and there’s more than one way to incorporate the benefits of a Roth IRA into your gifting plans. Because qualified deposits into a Roth IRA grow tax-free, and because there are no required minimum distributions (RMDs) for Roth IRAs, these accounts are an excellent way to show the next generation the real-world benefits of smart, disciplined saving and investing.
One way to do this is simply by contributing to a Roth IRA held in the child’s name. Even if the parent or grandparent doesn’t qualify for a Roth IRA of their own because of income restrictions (individuals earning above $139,000 and couples earning above $206,000 annually cannot make qualified contributions to a Roth IRA), they can contribute to a child or grandchild’s Roth IRA, as long as the child has earned income equal to or greater than the amount of the contribution. So, if a child earned $6,000 at a summer or part-time job, the parent or grandparent can gift $6,000 (the maximum annual contribution) and deposit it in a Roth IRA in the child’s name.
Obviously, for a young person, the potential future value of the account after compounded growth can be impressive. And with the ability to make qualified, penalty-free withdrawals from the Roth IRA account for expenses like higher education or the purchase of a first home, it’s a perfect way to nurture a lifelong habit of saving and investing.
Roth IRAs can also serve as a way to transfer wealth from one generation to another. Because no RMDs are required, Roth IRAs can continue to grow, tax-free, for the entire lifespan of the owner. And if the owner chooses to name a child or grandchild as the beneficiary of the account, the Roth IRA will pass to that person upon the death of the owner, continuing to grow tax-free as long as the funds remain in the account. It’s important to note, however, that the rules have recently changed for when RMDs must be taken for inherited Roth IRAs (accounts that pass to anyone other than the spouse of the deceased owner). Under the SECURE Act of 2019, a non-spouse who inherits a Roth IRA must take distribution of the account balance over a span of ten years from the death of the original account holder. This applies only to Roth IRAs that were inherited after January 1, 2020.
In my work with thriving retirees, one of the things I most enjoy is supporting them as they offer financial wisdom to younger generations. If I can help you develop a strategy for supplying “teachable moments” to children or grandchildren, I would appreciate the opportunity to hear from you. And to read my recent article, “Teach Your (Grand)Children: Creating the Financial Culture for Future Generations,” please click here.
Stay Diversified, Stay YOUR Course!