319 | Make Your Kid a Millionaire | ChooseFI podcast - Listen or read transcript on Metacast

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Episode description

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Episode description

Do you want to give your children the tools they need to guarantee their path to financial independence? If you give them the right skills, becoming a millionaire can be a mathematical certainty.

Achieving the objective of becoming a millionaire isn’t nearly as important as the process of getting there. Success is in the journey.

For many of us, we made a lot of mistakes before finding the right information and learning that there is a better way.

When you understand the power of compounding, you know how plausible it is to become a millionaire, and what you need to put away each month to get there.

Much of the journey comes down to mindset, empowerment, and believing that you can make changes to better your life. It starts with the little changes that make your life 1% better.

It’s time to stretch the tactics we use and apply them to a different age bracket. We generally talk about investing timelines starting around the age of 20. But how early could you really get started and why would you want to get started at an earlier age?

For Brad, the reason is dual-pronged. He thinks the concept of saving for retirement is misdirected and he would frame it differently. Retirement is so far in the future, it’s harder to get behind during your younger years. However, the concept of financial independence is something people are more willing to take action on.

Financial independence means you can control your time and have the autonomy to make decisions and you can take advantage of retirement vehicles such as 401Ks and Roth IRAs to reach FI.

Financial independence is a better framework for talking about and planning what it is you want to do with your life as well as giving yourself options.

The Make Your Kid a Millionaire article emphasizes Roth IRAs. Bradd says there has never been a great explanation of how people can take advantage of a Roth IRA for children who have earned income.

Most children don’t have jobs that allow them to contribute to a 401K, 403b, or 457. A source of earned income does allow them to make after-tax contributions to a Roth IRA where that money can grow tax-free forever.

A 12-year-old will have 47 years of compound growth before making withdrawals. All of the growth, dividends, and capital gains distributions will be tax-free compared to an investment account where they would be taxed.

The current limit for Roth IRAs is $6,000, but you may only put as much of that limit in as you have earned. A child earning $5,000 in a year would only be able to contribute $5,000, not the $6,000 limit.

Although ChooseFI doesn’t generally suggest the Roth IRA as the first investment vehicle to use, the strategy is different for children.

For adults, some financial independence strategies help to control your marginal tax rate using specific pre-tax retirement accounts.

When adults are in a low marginal tax bracket, an argument can be made for locking in the low tax rate with Roth contributions.

However, children with much lower incomes, already have low marginal tax rates. Since they can generally only choose from traditional or Roth IRAs, it’s likely in their best interest to pay the small amount of tax and then shelter that income from taxes for the rest of their lives.

Although allowance and pay for chores around the house don’t count for earned income, there are some categories of work kids may do that do count but you’ll want to be careful documenting, such as newspaper routes, babysitting, mowing lawns at other people’s homes, acting, photography, acting, modeling, or working for a parental-owned business.

Regular jobs at private or public companies that comply with your state’s child labor laws definitely count as earned income.

In the article, an example used discusses a child who mows lawns and earns $4,000. His parents decide to contribute $3,000 to a Roth IRA. The contribution does not need to be made with the exact same money the child earns. Parents or grandparents could make the contribution as long as it does not exceed the earned income or IRA contribution limits.

Matching programs are a great way to teach financial lessons. Similar to a company 401K match, parents or grandparents could incentivize a child to contribute to their Roth IRA by agreeing to match contributions dollar for dollar, or two dollars for every one.

If a 9-year-old were to put $3,000 into a Roth IRA once, never contribute again, and not touch it until the traditional retirement age of 64, that child would have almost $124,000.

With the power of compounding, a child needs to contribute just $1,500 each year of their lives to ensure a million dollars at a retirement age of 64.

In contrast, someone waiting until the age of 31 to begin investing and maxes out their Roth IRA with $6,000 each year until age 64 will only have $764,000. The difference between the two net worths is the result of the powers of compounding and time.

The Rule of 72 is a way to predict how many years will take your money to double based on an interest rate. You take the number 72 and divide it by your interest rate. 72 divided by an interest rate of 7% results in money doubling roughly every 10 years. Compounding on a big number adds up quickly.

A child could theoretically put in a large amount for just a few years, never contribute again, and end up with a higher net worth than with the $1,500 each example.

The article contains different scenarios to help foster the conversations parents can have with their children about the impact time can have.

Break through the initial resistance to get started and set up a system to reinforce good financial habits so that your child can build their own trust fund.

It’s hard to put a price tag on the psychology of teaching your kids about investing early. They will have a better foundation and desire to learn and get even better. It’s good to teach them the time value of money while they aren’t relying on it to pay for their survival needs.

Resources Mentioned In Today’s Conversation

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