Consider a gift toward your child’s retirement

As the end of the year soon approaches, think about how you can make a gift today that can impact your minor child’s future — more precisely, your child’s future retirement. Admittedly, that’s a long way off if your kids are under 18. Nonetheless, I’d like to remind you that retirement is the toughest goal for young adults to save for as life starts to intervene. And, it’s the easiest problem to solve if you are aware of how to leverage time.

Let’s talk about parents and gift-giving, kids and babysitting, and taxes and time.

Here we go.

Parents and gift-giving.

There is nothing stopping parents (or grandparents) from making cash gifts to their children directly — or indirectly by funding a custodial savings or brokerage account in their names.

Kids and Babysitting. If the minor children earn income for babysitting or other jobs, that income qualifies as “earnings” for IRA purposes. As long as the child has earned income, Roth IRAs are a definite possibility.

Taxes and Time.

To avoid tax-drag, there is no better vehicle than a Roth IRA. Earnings are tax-free, not merely tax deferred, and in contrast to traditional IRAs, there are no RMDs (required minimum distributions).

Time is the essential element to maximizing the impact of a gift. If that time is spent without having to pay taxes, what can be better?

Let’s go through an example. Your 12-year-old daughter, Janette, babysits for the neighbor’s children. So far this year (2023), she earned $500. Based on Janette’s earnings, she qualifies for a $500 Roth IRA, which you can set up for her.

To give you an idea of how significant setting up a Roth IRA can be, let’s say Janette earns $500 a year until she is 18, for a total of $3,500. After that, no one adds any additional money to her Roth IRA ever again.

What might the future look like? If she invests wisely earning an 8% return over the next 40-plus years (a well selected stock mutual fund will do the trick), she can reasonably expect to have over $170,000 by age 65. That 8% return is the historical return for the worst performing 40-year period in the U.S. stock market.

If Janette happens to live through the best performing 40-year period, she might even achieve a 12% average annual return. That would put Janette’s Roth account at over $1 million at age 65.

How can an investment of $500 a year for seven years grow to a million dollars? When the markets give you long-term opportunities, taxes do not eat away at returns, time gets to works its magic. That’s the simple math of compounding. What do you do next?

Call your mutual fund company, broker or financial adviser. Confirm that they can offer a Roth for a minor (not all Roth custodian agreements allow for parents or guardians to sign on behalf of a child). Fill out the application, choose your investments and send in your check. It’s as easy as that.

As an alternative, Fidelity offers Roth IRA brokerage accounts for 13- to 17-year-olds. Called the Fidelity Youth Account, the account is owned by the minor, who makes the investment decisions.

Be alert to IRA caps. The 2023 IRA limit is $6,500 for individuals under the age of 50 and $7,500 for anyone 50 or older. The limits for 2024 are higher: $8,000 if age 50 or older and $7,000 for everyone else.

You might be thinking about Janette’s accessing her Roth before retirement. When helping clients with this type of gift, we clarify that the Roth is a word of honor gift. The child understands it’s “hand’s off ” and really not something to even think about. (There are also penalties for withdrawing funds before age 59-1/2.)

If invested for growth in stocks or stock mutual funds, this money can grow and compound over and over before your children start to take any money out. I can’t think of a better, more impactful, gift.

Seasoned investment counsel (tinyurl.com/52nus8hz) and awardwinning columnist and author, Julie Jason, JD, LLM, promotes financial literacy and investor protection. Read her latest book, “The Discerning Investor: Personal Portfolio Management in Retirement for Lawyers (and Their Clients)” (tinyurl.com/4u7h9pjs), published by the American Bar Association. Write to Julie at readers@juliejason.com. While all questions cannot be answered, each email is read and reviewed and can lead to discussion in a future column.