Make Your Kid a Millionaire For Less Than $1 a Day
Using a Compound Interest Math Calculator, knowledge of u.s. tax sheltered accounts, and recent tax law changes you can set your kids up for financial success
“Should we have another one…”
Planning for your family’s future financial security is important and we can’t all just rely on the kiddos as they get older.
We would argue a key to having financial security is to harness the power of time, consistency, and compound interest to accomplish your goals as well as set the kiddos up on a much better financial path.
Now, when it comes to the kids, teaching them to be able to manage and handle money appropriately is equally if not more important than just giving them financial security, but today we wanted to give you a few creative tools to plan for the future and teach the kids about money in the process.
As a primer, in this quick 5 minute read we are going to help you out down the path of long term financial security by addressing the following:
Discussing what compound interest is and how it works to your advantage
Discussing how to use it to your advantage in a Roth IRA
Showing you how to make your kid a millionaire for less that $1 a day
Discussing new tax law in the US and how it makes a 529 savings plan more valuable
Giving you a creative way to use a 529 plan and a Roth IRA to set your family up financially
Let’s get started!
What is Compound Interest?
Compound interest is when you earn interest on both the money you've saved and the interest you earn. Warren Buffet, one of the most famous investors in the world, has basically built all of his wealth off of this principle. He famously notes, “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn't … pays it.”
So compound interest works like this: If you save and invest money today, it will earn you a return and increase your total amount in larger numbers over a set period. This return continues to get bigger over time as you have more and more saved earning a return (it works kind of like a snowball rolling down a mountain getting bigger as it goes).
For example, lets say I invest $1 and make 100% return in a year (pretty good!). The follow year I will start out with $2 (making $1 and still having my original $1). Now lets say that year I make 100% again (because you are an amazing investor!). Now you have $4 and made a gain of $2 vs. the $1 gain you made the year before (because your starting amount was bigger). As time goes on, you can see how this number builds and builds so long as you keep the money invested and you continue to earn a return.
The only thing left then that might dent this power of compounding would be having to give up any money after it has compounded (i.e. to taxes) when your amount saved and invested is larger.
Great, So What Does This Have To Do With a Roth IRA?
In simple language, a Roth IRA is an account used to save money for retirement. What makes a Roth IRA unique is that contributions to the account come after taxes and it allows the money to grow tax free and be withdrawn tax free after the age of 59½ (assuming the account has been open for at least five years).
A Roth IRA usually can be opened by any US citizen or non resident just so long as you have a Social Security number from the Social Security Administration or an Individual Taxpayer Identification Number (ITIN) from the Internal Revenue Service (you can have a relative do it if you live abroad).
There are yearly contribution limits ($6,500 for 2023, or $7,500 if age 50 or older) but you can contribute to someone else’s plan or you can have someone else contribute to yours (maybe you have a generous family member or relative living in the US if you live abroad and want to apply this tactic). You can also change the Roth IRA holder name in certain instances (ex. most cases involve a significant life event like a birth).
Regardless of whether you are investing long term for your kids or for yourself, using a Roth IRA will help allow your money to compound without the burden of having to pay taxes once you are ready to take it out.
So How Does This Help Make My Kid a Millionaire?
As noted, the beauty of a Roth IRA is the ability to avoid taxes on withdrawal assuming you at 59 1/2 as well as allowing anyone to contribute to it so long as you don’t exceed the maximum allowable yearly amount.
You as a parent (or generous relative) can start by setting up an IRA for your kid or kids (they don’t even have to be born yet but lets assume they are).
If you contribute just $30 a month to the account (or 98 cents a day) and invest in primarily in stocks (which average an annual return of 10% over the last 50 years - a simple index fund like the S&P 500 will do), by the time your child is 59 1/2 and ready to start withdrawing money, there will be over $1 million US dollars in the account.
However, this is obviously just an illustration and there are lots of ways to contribute. You can contribute more or less than $30 a month and you can even get the kids involved in contributing their allowance once they are old enough as a teaching tool. Whatever amount or path you decide, the important thing is that you stay consistent and keep your money in the account in order to let it grow.
If you want to play with some of these assumptions yourself around what you put in each month, length of time, and what it might return, check out our handy compound interest calculator.
Ok, Now Let’s Get Creative: What Is a 529 plan?
A 529 plan is a savings plan designed to help families save for their children's higher education expenses. These plans, named after Section 529 of the Internal Revenue Code, are sponsored by states, state agencies, or educational institutions and are authorized by federal and state laws.
One of the biggest benefits of a 529 plan is that the money in the account grows tax-free as long as it is used for qualified education expenses, such as tuition, fees, room and board, and books. Additionally, many states offer state tax deductions or credits for contributions to a 529 plan.
529 plans generally have the same rules as Roth IRAs above in terms of who can set up one, but there are some rules by state for non-resident aliens (for more information click here).
What Does a 529 Plan Have To Do With a Roth IRA?
Due to a recent law passed in December 2022 by the US Congress, If the beneficiary of a 529 plan does not use the money for qualified education expenses, the account owner can choose to either withdraw the money and pay taxes and penalties on the earnings, or starting in 2024 you can roll the money over into a Roth IRA for the beneficiary.
Rolling over the money into a Roth IRA allows the earnings to continue to grow tax-free, but they will no longer be restricted to education expenses and can be used for any purpose in the future.
To convert a 529 plan to a Roth IRA, you will need to open a Roth IRA account for the beneficiary and then complete a rollover process with the 529 plan administrator. This process may include completing paperwork and providing information about the new Roth IRA account.
Getting Really Creative: This Is How You Use Rule Changes To Your Advantage
If you have a young child, older child, or infant, you can start by setting up a 529 plan in their name (if you have a relative who has kids or want to set it up for your unborn kids you can set up the 529 plan in your name or a relative’s name).
Then, similar to the IRA example above you contribute 98 cents a day to the plan (or $30 a month), and just watch as your kid grows up.
Should you want to ultimately use the money for higher education when the time comes, you still have that option.
But should you learn that for whatever reason you don’t need the money for your child’s education, with the recent law change you can roll it over into a Roth IRA and give them a nice nest egg to fall back on once they retire!
Final Thoughts…
To wrap up, as we noted at the top, we feel teaching our kids to deal with an manage money effectively is equally if not more important than just giving them money to help (that’s why should you choose one of the paths above we would recommend getting them involved to contribute at some point as a learning tool).
However, using the tools talked about in this article can go a long way to helping your longer term financial security as well as your family’s security.
We hope this article was helpful and we would love if you would share it with friends on social media by clicking one of the links at the top! You can also shoot us a note or let us know anything you want us to write about in upcoming posts to help you further!
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