Let’s have Millionaire Kids, and Build Generational Wealth!

Remember what I said about the IRAs? Yes, compound interest is the key to growing money. Now, let’s add TIME to it. The more time you spend investing, the better it is! Hence investing for your precious little humans at an early age is paramount! So, one of the best ways to secure your children’s future is to save and invest through a Custodial Roth Individual Retirement Account (IRA). The great thing about those accounts is that there is no age requirement.

For a refresher on IRA, read Traditional IRA? Roth IRA? What are those things?

Now let’s talk about how to set the little ones up for their future

As I stated in the previous IRA blog, anyone with earned income can open an IRA, whether a traditional or Roth based on your income. To know if you can open a custodial IRA for your little one, you must know what the IRS means by Earned Income -all the taxable income and wages you get from working for someone else, yourself or from a business or farm you own. So for your child, it can be money they earn for chores, summer jobs (babysitting, lawn mowing, etc.), or part-time/full-time jobs.

The Custodial IRA has the same annual contribution as the adult one. You may be asking how a child can contribute $6,500/Year when they probably are barely making any money. Well, the great thing about Custodial Roth IRA is anyone can contribute, meaning the child, the parent, grandparent, aunt, godparent, and even friend, as long as the sum adds up to no more than the yearly max contribution of $6,500 (Year 2023).

A quick example:

Let’s say Jon Doe Jr. is 5 years old in March 2023, and you open a custodial IRA account for him since you are already paying him to do chores around the house:

Initial Investment $0

Annual Contribution: $6,500

Age at Retirement: 62 years old

Average Annual Return Rate (if invested in ETFs/Mutual Funds):10%

Marginal Tax Rate (Tax Bracket): 22%

Total Contribution: $370,500

AT RETIREMENT, THEIR ROTH IRA COULD BE WORTH $16,284,952.

YES, 16 MILLION PLUS!!!

What is a Custodial Roth IRA?

It is an Individual Retirement Account that an adult opens for a child under the age of 18 years old. Just like an adult Roth IRA, the contributions are made with post-tax money, therefore, the account grows tax-free

How can a child open an Individual Retirement Account (IRA)? Opening a Custodial Roth IRA for a child is as easy as opening an IRA for you. Some brokerage firms require you to have an account with them, and some others you can just open it for the child. You do not have to be a parent to open the account for the child.

Who controls the Custodial IRA?

The adult controls the money and investments in the account until the child reaches a certain age in their states (18,21, or 25 depending on the state). Upon turning that age, the account MUST be transferred to the child that it was opened for. The account cannot be transferred to another child.

Can withdrawals be made on the account?

Withdrawals can be made at any time penalty-free since it is a post-tax if the account has been opened for at least 5 years, and it must be made in the benefit of the child. Yes, the Roth IRA are retirement accounts, but they also provide great benefits:

• Ability to withdraw 100% of principal contributions at any time without a penalty. Let’s say you max out the Roth IRA for 13 years (giving that the child started earning money for chores since they were 5 years old), you would have contributed $84,500. The child would then be able to withdraw the whole amount penalty-free

• Ability to withdraw up to $10,000 principal and/or interest penalty free to use towards the purchase of their first home

• Ability to withdraw for Qualified Education Expenses penalty-free

What investments should you buy in the Custodial IRA?

Again, it’s just like your personal IRA, it is a matter of what the goals are and since the child is young, they can afford to be a lot riskier. I personally invest in Mutual funds and ETFs instead of individual stocks.

Historically ETFs and Mutual Funds have had an average Annual Rate of Return of 8%-10%. Your bank’s Annual Interest Rate is about 0.08% on a good year! So, just putting money aside for the little ones in a savings account is as bad as putting it under the mattress like our parents/grandparents did.

So, you know how we calculated the numbers for Jon Doe, Jr., and saw that he would be a multi-millionaire by the time he retired giving that you taught him financial literacy. Let’s say Jon Doe, Jr. taught his children and grandchildren the same, this would be how generational wealth is built. Remember, you can withdraw money at any time from the Custodial Roth IRA.

Let’s get even a bit deeper:

Jon Doe Jr. withdrew $10,000 penalty-free and tax-free from the custodial IRA you transferred to him and used that as a down payment to purchase his first home. Jon Doe Jr. bought a quadplex- a multifamily home with 4 units using an FHA loan, lives in one unit and rents out the other 3 units, and now has additional income while living rent-free. He then can use the additional income to invest in whatever his heart desires such as more real estate. He was able to do that because you added him as an Authorized User on your credit cards, so he had great credit when he turned 18 years old. See where I went with this!

Again, when it comes to growing money compound interest and time are key, and the little ones have that-TIME. So, investing early and staying consistent is paramount. Teach the little ones discipline and financial literacy at a young age so they won’t have to get it out the mud.

Our kids, they don’t need the new iPhone; they need ETFs and Mutual Funds.

The blog articles on this website are provided for general educational and informational purposes only, and no content included is intended to be used as financial or legal advice.