If it were not for Senator William V. Roth, Jr., folks like us would not be able to access one of the best retirement planning, college planning and estate planning tools ever devised. He gave us the Roth IRA. And we know the drill. Money goes into this account post-tax and once there, grows tax-free and can be withdrawn tax-free. You have to be about 60 years old at the earliest to be able to withdraw the funds but there is no requirement to do that (unlike 401ks and traditional IRAs). The money can technically compound forever until of course you are no longer on this planet at which point it passes down to your heirs and that too tax-free (more on that later).
Let’s use a simple scenario to drive home the point about the wonder of this account. Ava (her again…), who at the ripe young age of 20 realizes the benefits of this account and somehow manages to contribute the maximum allowed that year and every year after that. Now that she is in her 20s, she decides that she can handle whatever volatility the markets throw at her and spreads the money around in stock type choices across the globe. By the time she is 60, she would have had amassed anywhere from a million bucks to $2.5 million depending upon how the markets do over those years. And that’s just from those Roth contributions. Delay the need to withdraw for another 10 years and she is looking at anywhere from $2.5 to $6.5 million at which point if she decides to take the money out, she can, all at once if need be. No tax, nothing.
But college planning? How does a Roth help there? Only the fortunate and determined few have the ability to max out their pre and post-tax retirement accounts and still have money left over to pay for college. And as we have always said, saving for college is completely discretionary. Planning for retirement comes first because there are no loans, no grants to pay for that. But there is one big advantage with a Roth and that is that the contributions you have made over the years can be withdrawn tax and penalty-free if there was ever a need to pay for college. And that’s no chump change. If mom and dad each max out their respective Roths, the total contributed amount can easily top $200,000 from the time that kid is born to the time he or she is about to enter college. And you can tap that amount if there is a need. The icing on the cake is that the money in these accounts is invisible to the college application process.
This tax-free compounding of assets in a Roth can also become a powerful estate planning tool in case you never, ever have to take distributions from this account. It’s not completely out of the realm that money set aside in these accounts can compound to such staggering sums that it can cover the retirement needs of your heirs without them having to save a dime on their own. I know, I know and the intent here is not to raise a bunch of spoiled-brats or trust-fund babies. The goal is to provide options, allowing them to live a happy and content life, a life where they choose to work on things not because it pays well but because they truly, truly love what they do. As the Oracle of Omaha says, the goal is to leave enough wealth for your kids so that they can do and accomplish anything they want in life but not so much that they don’t do anything at all. So what if your son or daughter wants to pursue liberal arts or take a few years off and travel the globe or work for a non-profit. The wealth bestowed upon them through this account will potentially allow them to choose work that they truly love and make a difference at, a shot we probably never had.
But there are income limits though (check for IRA Contribution & Income Limits in the search bar on this page) so not everyone qualifies to do a Roth but if you do, don’t overlook this amazing planning option because every year you miss is one year’s worth of contribution gone…forever.
Image credit – Guiri R. Reyes, Flickr