FAMILY GOVERNANCE

The Most Powerful Investment Account Ever Created

What do you think is the most powerful investment account? An offshore account? A private Swiss bank account? A lockbox containing gold coins? Maybe a complicated trust? Not even close – the greatest investment account of all time is not nearly that exotic.

It’s the tax-free Roth IRA. No income tax. No capital gains tax. No distribution tax.

Why am I so confident that it is the Holy Grail of long-term investing? Because the federal government makes it so very, very difficult for wealthy individuals to use it. Nearly impossible.

  • First, the government limits how much you can contribute annually: $6,000 in 2021 ($7,000 for over 50s).

  • Next, the government limits the income level that disqualifies you from making full contributions: $125,000 in some situations.

  • Finally, the government requires that the individual must have some employment income.

The creators of the Roth IRA clearly knew how powerful this account could become, so they limited it to middle-income workers and low annual contribution limits.

Ingenious! Create the most powerful investment account of all time … but let only a few people use it.

Yet I know a lot of people who would benefit, such as our clients’ children and grandchildren between the ages of 18–27. They typically have a small amount of earned income from summer employment or first full-time jobs, but not enough to disqualify them from making Roth contributions.

Plus, these young individuals have 50+ years of tax-free compounding ahead of them. If they make just one $6,000 contribution to a Roth IRA … compound at 7% for 50 years … their balance at retirement could be over $175,000. You and I may not be there to see it, but that’s one heck of an investment!

However, young adults do not have $6,000 of extra cash lying around to invest for retirement. That is why parents and grandparents need to gift it to them, and why this concept falls under this quarter’s Family Governance section.

Helping your young family members to create and fund a Roth IRA is one way to teach them about investing and to help grow their financial literacy. Roth IRAs establish an understanding of employment income, compounding growth, and taxes.

Not sure what Family Governance is?

Roth IRAs can offer a little employment challenge, too. Tell your heirs that you will match their W-2 statement dollar-for-dollar as an incentive to work hard. They keep the earnings, you make the deposit. Roth IRA deposits are accepted until April 15 of the following year. There is even a Roth UTMA IRA for kids under 18.

We use these accounts to teach our clients’ kids about stewardship. We teach them that it is their money, their responsibility, but their parents provided it. If parents ever fall on hard times, this is money the children might use to support them. So far, this framing has worked: kids understand the stewardship concept.

Could the kids use the money for anything other than retirement? Sure. Educational expenses, first-time home purchases … various exceptions exist for tax-free distributions before age 59 ½. Consult a tax accountant for details.

Wealthy families may discount this idea because it is such a tiny share of their family’s total wealth. Do not let this prevent you from capitalizing on an opportunity to include your young heirs in the investment of family assets. The tax-free structure of Roth IRAs is an incredible bonus, and one that likely only the young adults in the family can capitalize on.

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