Estate tax planning is a subject which all parents should concern themselves with. Its fundamental goal is to pass as much of your estate on to your family and loved ones on a tax-free basis as possible. One simple but very effective tool to help you accomplish this is the Roth IRA.
The Roth IRA is an after-tax retirement fund which can produce substantial tax savings because all of its distributions are made tax-free. With the Roth, contributions into the fund are not deductible as they are with traditional IRAs or 401(k) plans. Instead, Roth contributions are made with after-tax dollars. However, once the individual reaches the age of 591/2, all of the fund’s distributions are made tax-free. Let’s take a look at it by running a few numbers.
Of course, the biggest ally of any retirement planning is the abundance of time. The more years that you save toward your retirement, or put more plainly, the earlier that you start saving, the larger your retirement bundle will be when that time comes. You can transfer relatively small amounts of money to you child right now. For example, if you were to open a Roth IRA with $4,000 for your 16 year-old child, it will have an opportunity to grow tax-free for forty-three years. Assuming ten percent annual growth, the value of the account at your progeny’s retirement would be around $200,000, and that full amount would be distributed on a tax-free basis.
But before you rush out and open up a Roth for Junior, you’ll need to make some determinations. As a parent, it’s very important to the healthy development of your children that you begin to teach them the value of money. They must be taught what money is used for as well as what it should not be used for. The concept of saving and investing for future good should be instilled. Of course, these will not necessarily be the easiest lessons in the world to get over to them, but be persistent. It’s crucial to their overall well-being.
There is also a practical application for these lessons. You’ll need to ensure that your child is mature enough to be able to handle the responsibility of a long-term investment account. This is because the Roth IRA must be opened in their name. Your child will have the legal right to use the account in whatever way he or she chooses to. That’s why you must make clear the advantages of using the account correctly as well as the consequences of using it unwisely. They have to understand that withdrawing money unnecessarily will result in taxes and penalties which they will be responsible for, not to mention robbing the retirement nest egg that the account was opened for initially. Be objective, but be sure beforehand; once it’s opened, the decision on how to use the account rests solely with them.
Opening a Roth IRA for your child can be a very effective means of transferring wealth as well as teaching important financial lessons. If your child acts responsibly with regard to it, your small Roth contributions can grow into a very substantial retirement amount.