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How a Simple IRA Could Make Your Kid a Millionaire by Age 30

The birth of a child is a time for celebration and joy. The sudden miracle draws so much attention that we fail to think about that tiny person’s future. If properly invested and financed continuously over adolescence, that child’s investment will also mature. Parents targeted for success will more likely motivate their children to achieve financial success in the future.

The power of specialized retirement accounts and compound interest is on the side of youth. Of course, always speak with a financial and/or legal professional that understands your specific set of circumstances before doing anything that may affect your rights.

What Is an IRA?

An Individual Retirement Arrangement or IRA is a tax-deferred system to encourage savings after your working life. The reason it is called an arrangement is that it is a long-term promise that one makes with the Internal Revenue Service (IRS). Rather than saving your extra post-tax dollars, the government created the IRA system where your pre-tax dollars are invested. The government allows the money to grow in an account tax-free until you turn 72. At that point, you can still invest in an IRA, but you will need to make a Required Minimum Distribution or (RMD), which is taxed at your future income tax bracket. 

This has a wonderful effect on a person’s current taxable income rate, as well. This is because any reduction you make to your “gross” income and place into an IRA account results in a subsequent deduction in your total income. To explain this more clearly, imagine you earned $1,000 for a specific time period, and you are in the 35% tax bracket.

If you did not contribute to an IRA, your total taxable income is $1,000. Had you contributed $100, previously calculated to be your maximum for that pay period by HR, your taxable income would have only been $900. Without the IRA contribution, you would pay about $350 in federal income tax. With an IRA contribution, you would pay about $315 in tax. That is a $35 savings per pay period. If you spread that over the entire year, your lower income means that it will be harder to be forced to pay more tax in a higher tax bracket. 

How To Open an IRA for Kids

Before you call and yell at your parents for not doing this for you when you were younger, there are a few things to consider. First, all contributions to an IRA must be in the form of “earned income.” That means the child has had to have worked and earned an income at some point during the year to be eligible for an IRA. It is not uncommon for parents to have arrangements with their children where the child spends the money on education or professional advancement in exchange for the parent(s) funding the account. Unfortunately for the parent, that contribution is not deductible for themselves. But it will get the child thinking about planning for the future.

**A brief word on FAFSA, the financial aid form all students must fill out to borrow money in college. When a school calculates a student’s financial aid package, it only adds up “included assets” and not “excluded assets.” IRAs are excluded so long as no early distribution was made, and only that amount is includable. This is true even though you are opening a custodial account under the Universal Transfer to Minors Act (UTMA).

All UTMA and Universal Gift to Minors Act (UGMA) custodial accounts are includable on the FAFSA unless they are held in an IRA or other FAFSA-excluded account, like a SEP. The account can be opened at nearly any FINRA-approved brokerage or investment institution. Make sure the person is a fiduciary though, of course.**

What Is the Definition of Earned?

Now the question arises: what is the definition of “earned”? The IRS does define earned as “working.” Therefore, a baby, unless it is a child model, will not be able to earn money in an office. But I remember when I was ten years old and stocking the shelves in my father’s pharmacy. That is reasonable, and I was (very importantly) paid a Fair Market Wage [FMW], rather than something exorbitantly high. The IRS does not look kindly on those trying to transfer wealth through a child IRA; therefore, the pay of the minor should not exceed a reasonable FMW.

The ability to document your child’s employment is crucial in determining whether or not to put that income into a Roth IRA or a traditional IRA. The most sure-fire way to prove actively earned income is with a W-2. If your child is a lifeguard for a local community center or a summer intern, that may not be a problem. But, if your child does ad hoc work as an apprentice or completes jobs like being a tutor, a youth leader, or washes cars — a W-2 is going to be nearly impossible without banking records and documentation sent to an accountant. Yes, 1099’s are also effective forms of documentation.

Difference Between a Roth IRA and a Traditional IRA

What is the difference between a Roth IRA and a Traditional IRA, and which one should I open for my child?

Continuing on from the last section, it was important to know if your child’s actively earned income was readily documentable. If it is, such as with a Form W-2, your child will be eligible for a Roth IRA, which has many more benefits for the child/future adult when they retire. Those specific benefits will be discussed in the next section. 

The most important difference between a Roth and a Traditional or SIMPLE IRA is that Roth means that the IRA account is funded with “post-tax” dollars. Therefore, the principle will grow tax-free and any qualified distributions will be tax-free. 

What Impact Does That Have on My Child’s Investment?

We are currently in the lowest tax regime in American history, ostensibly through 2025. Your contributions to a Roth IRA already paid the low-tax rate at present time. In the future, your child may be forced to pay much higher tax rates and possibly new taxes on their traditional IRA. This is because traditional IRAs are funded with “pre-tax” dollars. 

Unique Roth IRA benefits and limitations

Besides not having to pay taxes on principle or compounding growth and investment of your child’s Roth IRA, there are several other wonderful benefits of the Roth IRA. The largest benefit may be that Roth IRAs are not subject to RMDs. Currently, RMDs must be withdrawn from an account starting at 72 years of age. According to the IRS, “the RMD for each year is calculated by dividing the IRA account balance as of December 31 of the prior year by the applicable distribution period or life expectancy.” Life expectancy is calculated based on tables developed by the federal government and updated each year. This is an enormous benefit to those that wish to let their investment grow tax-free and/or wish to save it for a spouse or another relative. Granted if the individual does leave a bequest from/of their IRA account to an allowable heir, that beneficiary will still be required to spend it down within ten years (unless they were the last spouse).

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Long-Term Tax-Free Legacy Planning

This is the important difference in Roth status that must be understood. Inheritance of a Roth IRA is neither a taxable event nor its distributions. The inheritance of a traditional IRA is also not a taxable event, but its distributions are taxable. That means the inheritors of a traditional IRA will have to pay tax on the distribution itself, possibly increasing the tax bracket of the recipient of the distribution. The beneficiary of the inherited IRA, whether Roth or not, will have to spend it down within ten years time unless they were a spouse.

Cap on Contributions

It is important to remember that both Traditional and Roth IRAs have a two-tiered contribution limitation based on age. If you are below the age of 50, you can contribute up to $6,000. If you are over age 60, you can contribute an extra $1,000 in “catch-up” contributions. 401(K)’s, SEPs, and other retirement programs each have their own contribution limits. 

How To Make Your Kid a Millionaire: Best Tips

In case you are wondering how to become a millionaire by 30, It is important to have a robust plan for helping your child achieve lifetime success. The IRA system is just one possible method. There are other financial strategies to consider.

Do not overly educate

We typically encourage higher education for our children, especially college degrees. It is hard to argue with the logic and benefit of seeking a college degree, as on average, such individuals make about $1M more than an individual without a college degree over a lifetime. But, if the individual studies specialized medicine, the years of deferred income plus increased debt load results in a less of an actual positive variance in take-home income. The rate is about less than 8-10% more than a specialized, self-employed, blue-collar professional without a college degree. 

Give away grandpa’s IRA

As a caveat of how much good one can do with an inherited IRA, It is important to mention the Qualified Charitable Distribution or QCD. So long as you are over the age of 70 ½, and even over 72, the year RMDs are required, you can donate, without tax or effect on your taxable income, up to $100,000 to an IRS approved charity per year, generally. Therefore, instead of the income tax eventually being deferred to the point of distribution, it instead is tax-excluded and goes on to help the charity of your choice.

Summing Up: How To Make Your Child a Millionaire?

A Child IRA is the recommended method for helping your child become a millionaire in retirement. In order to do it properly before setting up the investment account, you need the expertise of a financial professional. As the parent or guardian, you would open an account with a reputable fiduciary of your choosing and have them aggressively invest the principle (or basis) of your child’s Roth IRA. If your child is able to sweep a floor at the age of five, and without breaking any child labor laws, that child earned a competitive, though not a high wage, you could contribute on their behalf up to $6,000 into an IRA. That basis can then be directed to invest aggressively with a return of over 12.65% and a yearly contribution of $6,000. 

Some of the best investments for return of that nature tend to be family-run businesses that distribute the profits gratuitously that still issue shares. In other words, have your financial planner consider directing your child’s IRA funds into shares of your business that pays out a dividend of 12.65% with a maximum contribution. If the contribution continues to increase, the ROI can be closer to 10%. In fact, if the yearly dividend or IRA contribution is part of an approved ERISA plan, the cost to the business would be similarly tax-deductible, including any matching program. 

These pieces of advice will help you and your child understand how to become a millionaire by 30 through investing. You should always prioritize long-term investments for a child to achieve the desired financial success.

Article by Brad Biren

Brad Biren is a proud autistic professional, writer, and advocate for neurodiverse people within the business community. He is a tax & elder law attorney with a passion for estate planning and crisis Medicaid planning. His favorite part of his job is Special Needs Planning — a financial and legal roadmap to help families of diversely-abled people cultivate greater opportunities for their loved ones. Biren also assists startups and nonprofits with optimization challenges through his innovative and novel use of synergies between tax, law, finance, science, and technology.

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