As parents, we want our kids to have the best. We want them to be happy, healthy, and successful in life.
And one of the best ways I can think to help aide them in building security is to set them up on the path for financial excellence from an early age.
This of course does not mean winning the lottery or transferring over your wealth. I’m talking about passing on the knowledge and skills necessary to help build wealth from scratch over the long haul.
With both of my children becoming teenagers and (within the blink of an eye) young adults, I’m thinking about this topic more and more.
In particular, I’m trying to decide how best to present this information to them in a way that sticks forever.
After some careful thought (and what I would consider a lot of generosity), I have an incredibly simple strategy that I think will work really well at setting both of my children up to potentially become millionaires! Not only will it help educate them first-hand as to how money actually works, but it could also help give them a BIG head start on their own paths to financial freedom.
In this post, I’d like to share my plan with you. Perhaps if you’ve got children (of any age) too, then this strategy might be of some value to you and your efforts to help them out with money.
Starting a Roth IRA at Age 16
Anyone who has ever played around with a financial calculator or anything that computes compounding returns knows that the earlier you start investing, the better off your chances for success are.
Of course, investing is tough when you’re a kid. The only money you usually earn is what your parents pay you. And even then, you usually want to use it for fun stuff anyways.
When I think back to my early financial situation, one of the biggest changes for me happened when I got my first job at age 16. I went from making a $5 allowance from my Dad to suddenly receiving hundreds of dollars from the restaurant I was working at every month.
As a natural saver, I was good about putting a big majority of that money in the bank. But if I could go back in time, I would tell myself to take it one step further. And so this is the advice I plan to pass on to my kids: Start a Roth IRA!
Let’s look at the simple facts that come with Roth IRA’s:
- First off, to even contribute to a Roth IRA, you need to have earned income. Therefore, their first part-time job will qualify them.
- Since this is a Roth-style account, they will pay their taxes now rather than later on in life. That’s great because when you’re 16 earning a part-time wage, you’re probably going to be in the lowest tax bracket of your whole life.
- Any money that grows on top of this money will be tax-free from now until forever.
- Starting a Roth at age 16 will also help them to get an early jump on the five-year rule for taking Roth IRA contribution withdrawals; just in case they ever need them later on in life.
To get started, let’s assume for one second that they invest the maximum amount of $5,500 per year into their IRA at age 16, 17, and 18. The money is invested in a stock market index fund earning an average annualized rate of roughly 10% (according to data from NYU).
At first, these 3 years won’t seem like much of anything has been accomplished.
But then, the longer we wait, the biggest benefit of starting early begins to kick-in: Compounding returns!
Compounding returns cause your earnings to grow exponential. Look at any graph involving compounding returns, and one thing will be clear: If you would have started earlier, there’s a great chance you’d be FAR MORE richer!
… this is where the beauty of this strategy lies! By starting at age 16, that’s almost 9 years before when most young professionals even start to think about saving and investing.
So – how much would those simple 3 contributions of $5,500 add up to by age 60 (44 years later)?
$996,973 – almost one million dollars!
(Of course, that’s without inflation. With inflation, this money would actually only be worth about $303,144 by that time. Not bad … but we’ll fix this problem in the upcoming sections.)
My Offer to Turn My Kids Into Millionaires
This all sounds good in theory, but how do you get a teenager to contribute $5,500 to a Roth IRA – especially when (to them) it feels like retirement is a billion years away?
My plan is simple: Make them an offer they simply cannot refuse. I will offer to match them dollar for dollar what they contribute to their IRA (combined up to the IRS max). In other words, if they contribute $2,750, I’ll kick in the other $2,750.
By IRS rules, this is perfectly legal so long as they actually earn $5,500 or more. If they earn less than this level, then that number becomes the new maximum level.
This will be sort of like when employers match your 401(k) contributions. I will use it as a way to heavily motivate them to save more and more – in addition to the prospect of one day having a physical balance of almost one million dollars.
But beyond that, this will also help them get the right footing for investing at a very early age. They can learn about mutual funds, index investing, and capital gains. Not to mention they will also see first-hand how investments can rise and fall with time.
Continuing to Encourage Financial Habits
So how can we develop this further into one million dollars of real, inflation-adjusted money in the future?
In order to do this, we will need to continue the process of investing $5,500 into their IRA for a total of 14 years (until they are age 29). By this point, their growth potential will be $1,010,219 with inflation adjustment (or $2,953,288 in nominal dollars).
How can I help ensure they invest?
During the college years, I could continue to make them the same dollar for dollar match into their IRA’s.
Hopefully by the time they graduate and get their first real job, they can then start making their own full contribution to the IRA. My bigger hope of course, is that by this point they realize what a golden financial opportunity this is and take even more advantage of it with their 401(k) plans as well.
In fact, if they did, becoming a millionaire would happen quite a few years sooner! Here’s what that same graph would look like if at age 24 they started contributing the max to both their 401(k) and IRA (up until they reach $1 million at age 42). (… yes, I know a young person investing that much that early is a stretch, but let’s just run the numbers and have some fun imagining the possibilities! …)
What’s not important here is whether or not they actually make it to one million dollars. As you probably know – what each person needs to be financially independent is as unique as the individual.
What is important is that I draw them into a world where they see opportunity. Putting compounding returns to work for yourself at such an early age is a ticket to wealth that not many people are given. It’s truly one of the most intriguing and passive ways to build your wealth. Hopefully my offer entices them to make the correct decision!
Readers – Do you have any plans for turning your kids into potential millionaires someday? If so, how do you plan to do this? What sort of lessons or strategies will you be using?
Featured image courtesy of Pexels