Tuesday, July 27, 2010

Investing for Children with a Twist on Inflation

I’ve written multiple posts on the importance of parents, relatives or friends starting to invest for children as early as possible and in turn teaching children about money as early as possible too. I’ve also a lot of support on how great the Roth IRA is for most people – including children. I recommend that along with this post, you read some of my earlier posts that:
I’ve received some feedback on some of the earlier posts and found that not all parents want to go through the steps that I went through by having to document and prove verifiable income for their child. Also, not all parents want to possibly have to file for income taxes for their young child either. Furthermore, some parents feel a little uneasy starting an investment in their child’s name – they have fears that once the child turns 18, they might just take all of the money and blow it on something frivolous.

If you share any of the above concerns, then I may just have the solution for you!

Let’s just assume that a parent sets up a Roth IRA at age 25, when his first son or daughter is born. The parent sets up the Roth IRA for himself and then only makes a one-time contribution of $1000.00 in that that first year, but makes the new born the beneficiary. Keeping the money in the parent’s name protects the money from being foolishly spent by the child, as well protecting the parent from having to prove verifiable income or file taxes for their new born.

If the parent were to die 60 years later, at age 85, the 60 year old beneficiary would inherit $1,292,377.00 – assuming a 12% average annual rate of return on the investment. This inheritance would be completely Tax-Free and would come with an option of taking the lump sum or of converting it to a “Stretch Roth IRA” in the beneficiary’s name. (Stay tuned – I will be discussing Stretch IRAs in more detail in future blog posts.)

Since the IRS law in 2010 allows up to $5000.00 in any one year to be contributed to a Roth IRA, if that were the original contribution, the inheritance could have been $6,461,885.00! Due to inflation, if we assume a 3% rate of inflation, that $6,461,885.00 in 60 years is only going to have the “Buying Power” of $1,096,582.00 in today’s dollars!

Some interesting facts about inflation: Inflation has relatively little affect over a 10 year period – a loss of 26% in buying power. However, over a 60 year period – like the example above – it represents a decrease of over 83% in buying power.

If you are bummed about that loss in buying power over 60 years because of inflation, just think of it this way: Your one-time investment of $5000.00 has increased 21,931.64% to $1,096,582.00 in 60 years!

I'm so excited to share this information with you. If you have enjoyed the information or feel that it would benefit someone else, please share it. If you have any questions or comments, please feel free to contact me.
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