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Time Is On Our Children’s Side

12610979 - little boy in black hat and tie at the table counts money, isolated on white Susan and I have written a lot of articles about the importance of starting to save for retirement as early as possible: taking advantage of time and planning for the future at a young age. We have covered topics ranging from how to teach our youth the value of saving to creating a budget to help them reach their goals to making a financial to-do list for graduates.
 
Susan and I speak about these subjects even more often to our captive audiences around the supper table. Our kids have heard us pontificate about the importance of starting to invest at an early age and the benefits reaped from being financially responsible later in life.
 
We both believe that our legacy is our children and we are pretty proud of our kids, as most parents are. Both of our oldest kids entered the workforce this summer. Both researched employment opportunities, interviewed, and were hired. Maeve, my daughter, is a hostess at the Flying Bridge (of course, she will remain part of the landscape crew with her sisters at Cutter Financial; she loves that). Susan’s oldest, Max, is washing dishes at the Captain Kidd.
 
Turns out, our harping about financial responsibility and planning for the future may be paying off! Both Maeve, who is 15, and Max, who is also 15, have started planning for their futures with a disciplined savings regime. And the best part is that they each took the initiative to ask us how to go about doing it. We hope many of you will hand this article off to your high-schoolers, so I am going to cover the basics of what we told both Max and Maeve, starting with the benefits of opening a Roth IRA.
 
A Roth IRA is an individual retirement account that offers tax-free growth on after-tax contributions. In other words, the owner of a Roth IRA does not get a tax deduction for his or her contributions, but all future withdrawals from a Roth, of both contributions and earnings, are tax-free, provided those distributions meet certain requirements.
 
A Roth IRA is one of the most tax advantaged retirement tools for a young person. Think about a farmer, who has just a handful of wheat seeds that weigh less than a pound. The farmer plants those seeds, lets them grow, and then harvests them at the end of the season. A few ounces of inexpensive seed turns into hundreds of pounds of valuable wheat.
 
Anyone can contribute to a Roth IRA as long as he or she has earned income from a job and has income below certain specified levels. However, contributions are limited to either $5,500/year if a person is under 50, ($6,500/year if a person is over 50) or the extent of earned income. So, if a summer job earns $3,000 and a kid does not “earn” any other money during the year, then the most he or she can contribute is $3,000.
 
A Roth IRA is a great savings tool for young people, for many reasons. Young people are almost always eligible to make contributions (I have never met a teenager who exceeds the income limits); and for the same reason, those young people typically do not need the tax deduction that would otherwise be available for Traditional IRA contributions, as they are usually already in the lowest tax brackets. But most importantly, Roth IRAs provide a mechanism to help our youth take advantage of many years of tax-free earnings. As Einstein said, “Compound interest is the 8th wonder of the world. He who understands it, earns it . . . he who doesn’t, pays it.” The same can be said for compounding of returns.
 
Roth IRAs are also somewhat flexible. It’s usually a pretty reliable rule that it is best not to withdraw from a retirement account until age 59 ½ or later. But young savers often require large amounts of money for things like buying a car, paying for college, putting a down payment on a house . . . and because the contributions to a Roth IRA account have already been taxed, they can be withdrawn at any age without having to pay an additional tax or penalty (which is why they are more flexible than Traditional IRAs). On the other hand, an account must be open for a minimum of five years and the owner must be at least 59 ½ years old to withdraw earnings both tax-free and penalty-free. However, there are exceptions to these rules for death and disability of the account owner, first-time home purchases and expenses related to higher education.
 
Maeve has committed to putting $2,000 into her Roth IRA, and her loving parents have committed to matching her contributions, bringing the total amount to $4,000. Between Maeve’s earnings from the Flying Bridge and her landscape work at Cutter Financial Group, $4,000 will not exceed her earned income. Max has committed to contributing 1⁄3 of his earnings to a Roth, (which his parents have agreed to match), adding 1⁄3 to a savings account (Max has plans to buy himself some big ticket items in the next year) and keeping 1⁄3 for “walking around” money.
 
Now, Susan and I realize that Max and Maeve may be more familiar with the benefits of saving and investing than most teenagers, after having to listen to us for so many years. And we understand that often, trying to convince a teenager to do something that will help them in 50 years is impossible. We believe that quantifying the possible benefits helps quite a bit.
 
Let’s assume at age 15, Max and Maeve can each expect an average rate of 6 percent return on their investments over the years. When Maeve is 30, based on her plan to contribute $4,000 a year, her Roth IRA will likely be worth almost $110,000. When she is 50, it will be $550,000. At 65, get this, almost $1.5 million. I explained to Maeve that over those 50 years of saving, her total contribution of $200,000, with compounding returns, could turn into $1.5 million!
 
Alternatively, if Maeve were to wait until she is 30 to start contributing to a Roth IRA, her $4,000 per year would only turn into about $375,000, based on the same assumptions. The life lesson here is that a little dedication now will pay off big in the future. By starting so early, they both have time on their side.
 
One last note about Roth IRAs is that, unlike the Traditional IRA, which has required minimum distributions (RMDs) beginning at the age of 70 ½, there is no RMD on a Roth IRA. Not only that, but remember, even if you take a distribution, it is all tax-free!
 
Susan and I feel fortunate to be able teach the importance of financial responsibility to our Cutter Family Finance readers and through the adult education courses we teach in Falmouth and at Cape Cod Community College. But we often feel that our youth does not get the information they need.
 
Folks, in our opinion, our youth are at a financial disadvantage. With so many headwinds blowing against them; things such as college debt, wage stagnation and the national debt, this generation needs to take responsibility for their financial future. Unfortunately, they are not taught any of this in school. So, we all need to teach them.
 
This young generation needs to be vigilant and stay alert, because, as I’m sure we can all agree, they deserve more.