Parents or grandparents should consider gifting to fund their young professional’s retirement account.

Your son or daughter recently graduated college and has his or her first real job.  You got them through with little or no student debt, they’ve got their own benefits and you’ve encouraged them to participate in their employer’s matching retirement plan.  Congratulations – you’ve got a lot to be proud of!  But is there anything more you can do right now as they’re getting established?  Consider helping them with a Roth IRA.

Most young professionals, because they don’t have the cash flow to fund it, are missing out on one of the biggest tax advantages they’ll ever see; the Roth IRA benefits of tax-free growth and tax-free distribution (provided the distribution is qualified.)  Unlike a Traditional IRA that may be tax deductible on the way in, grows tax-deferred but is taxed on the way out, Roths are funded with after-tax contributions and possible earnings never to be taxed again* (unless, of course, Washington changes the rules on us.)

It’s important to start with a Roth early in a career as they can only be funded below certain income limits.†   If your son or daughter is on an upward professional trajectory or is soon-to-be married, the Roth opportunity may not be there for long.

The maximum an individual under 50 can contribute annually is $5,500.  But that amount can become significant over time thanks to the compounding of the returns.

Let’s say a 23 year old contributes the maximum to a Roth IRA, makes no other contributions, takes no distributions and achieves a reasonable annualized return of 7.15%.  During the year after that individual reaches 65, the account will be worth $100,000 with no drag of taxes on growth or withdrawals and no forced RMDs (required minimum distributions.)

Where might the money come from?
How is a young person just getting started supposed to put away $5,500?  If the resources are available, a parent or grandparent is well under the $15,000 annual gift allowance if they give the $5,500 to their descendent.‡  Think about the legacy you could leave: if the one-time investment achieved an annualized return of 8% and had no withdrawals, the account owner would celebrate his/her 70th birthday with nearly $200,000 – TAX-FREE!*  The amount is even more staggering if subsequent annual investments are made.

While one may hesitate at locking money up for so long, two benefits of a Roth are that 1) up to $10,000 can be withdrawn for a first-time home purchase and 2) contributions can be accessed tax-free and penalty-free at any time.

While it’s not easy for young people to have the earning power and discipline to sock away additional money, it’s a shame to miss out on this great opportunity for tax-free growth and distribution.  With some help from Mom & Dad or Grandma & Grandpa, the opportunity might just be there. 

“Roth Early, Roth Often” I say!

* Only qualified distributions from a Roth IRA are tax-free.  Non-qualified distributions are subject to taxes and penalties.  Provided the account has been open for more than 5 years, once the account owner reaches 59 ½, the distributions are qualified and are tax-free.  Other qualified distributions may include those to an owner who is disabled, funds used for the first time purchase of a home, or assets conveyed to a beneficiary of an estate upon the owner’s death.

† For the 2018 tax year, Singles with Modified Adjusted Gross Income of up to $120,000 are eligible to contribute $5,500 phasing-out up to $135,000.

For the 2018 tax year, joint filers with Modified Adjusted Gross Incomes of up to $189,000 are fully eligible phasing-out up to $199,000.

The account owner’s earned income for the year must be equal to or greater than the amount contributed.

‡ Gifting means that the person giving the gift loses control and direction of the asset; the giftee can do with the money as the giftee pleases.  Also, consideration should be given to the gifter being able to do this for other children and grandchildren on an equitable basis.

This material is meant for general informational purposes only and is not to be construed as tax, legal, or investment advice.  Although the information has been gathered from sources believed to be reliable, individual situations can vary. Therefore, the information should be relied upon only when coordinated with individual professional advice.  Shore Point Advisors and its employees do not provide tax, legal, or accounting advice.  Consult your tax, legal, or accounting professional regarding your individual situation.

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