It might seem like a dream to plan on your children retiring with $1 million or more, but in all reality, making your kids millionaires might even be easier than becoming one yourself.
That’s because compound interest plays a huge role in the size of a portfolio. The younger you start investing, the more likely you are to end up with a sizable nest egg. This is particularly true when you use the right accounts. Retirement accounts are a great way to ensure that investment gains grow tax-deferred, and among these, experts like Suze Orman highly recommend the Roth IRA, particularly for kids.
So, what are the benefits of a Roth IRA, how much can your kids invest and how can they help build seven-figure account balances? Read on to find out.
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The Power of Compound Interest
A simple mathematical example will show that compound interest plays an incredibly powerful role in building wealth over time.
Imagine that you make regular $200 monthly investments to a portfolio that provides a 7% average annual return. Here’s how much you will have invested over various time frames, and how much your total account value will grow to:
- 10 years: $24,000 contributed; $34,616 account value
- 20 years: $48,000 contributed; $104,185 account value
- 30 years: $78,000 contributed; $243,994 account value
- 40 years: $96,000 contributed; $524,962 account value
- 50 years: $120,000 contributed; $1,089,613 account value
What this means is if your kids can start contributing just a scant $200 per month once they turn 16, by age 66, they can expect to have over $1 million in their accounts, assuming a 7% average annual return. This is a very minimal investment for such a large retirement account. If they boost their contributions once they start earning higher salaries, they could potentially earn multiple millions. The key is to start early and make consistent, long-term contributions.
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What Are the Advantages That a Roth IRA Provides?
The tax benefits that come with a Roth IRA are its biggest advantages. While all IRAs provide tax-deferred growth, Roth IRAs come with the big kicker — tax-free withdrawals in retirement. While your kids won’t get a tax deduction on any contributions, when they take their money out in retirement, it will be tax-free. Unlike with a traditional IRA, there are also no required minimum distributions at any time, meaning your child, as a retired adult, could keep their money in the account and take advantage of its tax benefits for as long as they like.
How Much Can Your Kids Contribute to a Roth IRA?
Per the IRS, the maximum contribution to a Roth IRA in any given year is $7,000, or $8,000 for those 50 or older. However, there is an important restriction, particularly when it comes to kids or those who may earn a smaller salary. Specifically, the IRS also limits Roth IRA contributions to the amount of taxable compensation. If your kids only earn, say, $200 in a given year, that becomes their maximum allowable contribution, not $7,000.
Strategies You Can Use To Help Build Your Kids’ Account Balances
If your kids start earning money at a young age, it might be a bit of a challenge to get them to divert it to an account like a Roth IRA, where they may not have access to the money for 40 years or more. But as the power of compounding shows, the earlier they can start to save and invest, the better.
One way to encourage them to start saving and investing is to offer to match some or all of their contributions. For example, if they’ll set aside $100 per month, you may offer to contribute an additional $50 or $100 on their behalf.
Education can be another way to stress the importance of saving at a young age. If you can show your teenager that they are almost guaranteed to be a millionaire at retirement if they save even a little bit now, they may be inspired to do so.
Another strategy could be to strike a deal with your kids, in which they’re allowed to spend as much as they save. For example, you might make an arrangement in which they get to spend $100 on whatever they want in exchange for socking away $100 into their Roth IRA.
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This article originally appeared on GOBankingRates.com: How You Can Help Your Kid Retire With More Than $1 Million
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