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[Editor’s Note: This is a guest post from Glenn Frank, CPA/PFS, MS (Taxation) who has submitted a guest post previously and has previously purchased advertising on The White Coat Investor. He owns Frank Advising, which analyzes the tax side of a portfolio for a quoted fee, and is a professor in the financial planning program at Bentley University. Enjoy the post. I’m curious to hear the comments on this one.]

How Will Our Children Survive? Our 50/50 Plan

Are you worried that social “insecurity” benefits and defined contribution plans will not sustain your children through their 30+ years in retirement? Will they save adequately? Will they invest prudently?

Our solution for their “survival” cash flow follows: First I have copied an email my wife and I sent to Cameron, our 20 year old. Secondly, I’ll discuss the plan behind the email and how we hope that gifts of $50,000 per child will generate $50,000 per year of tax-free income during their golden years.

Professor Glenn Frank

Professor Glenn Frank

The Email

Cameron,

A ROTH IRA is an account that you can contribute up to the greater of $5,500 or your reported wages on your tax return for the year. The tax-free accumulations can be tremendous, assuming the funds are wisely invested over time.  Retirement withdrawals are tax-free (there are penalties for early withdrawals). Per Einstein, “The greatest force on earth is compound interest.”

For example, using the rule of 72 – if your average return is 7% (72 divided by 7 = 10) then money doubles roughly every 10 years. A $1,000 contribution would be worth $2,000 by 2024, $4,000 by 2034, $8,000 by 2044, $16,000 by 2054 and $32,000 by 2064 (you would be about 70 by then). Imagine what larger contributions for more years can amount to!

We know it seems wild to think about your retirement now but it is never too early. The benefit along the way is the great feeling associated with financial security + at a relatively young age you may have accumulated enough to make your then current passion “affordable”.

We are committed to at least 1 full year of $5,500 to get you started. We will provide guidance on how to invest the money but it will be your decision. Note this is intended to be “untouchable” until you retire although it will be legally yours – the “honor system” will apply.

In essence, this is inheritance we are funding now due to incredible tax benefits and to get you thinking about the future.

Love,

Mom and Dad

Our Plan

A current investment decision should force an initial discussion about investing/saving. Annual contributions should spur annual discussions. They will need to be convincing to alter our proposed portfolio of 3 ETFs (all US Equity, all International Equity and Frontier markets). They will realize that any imprudence on their part may negate future contributions – that there is a difference between long-term investing versus short-term speculation!

Our tentative plan is to contribute roughly $50,000 in total for each child over the next 10 years (if not a ROTH maybe via their 401k –matching the company match on their contribution – we will see what their tax brackets are and whether a ROTH is best).

For Cameron – by age 30 at 7% he should have about $70,000 ($5,000/year + earnings) in his ROTH. By 40 it would double to $140,000, by age 50 this will amount to $280,000 and by 60 $560,000.

Alternatively these funds could have been kept under our control in our taxable account over the next 40 years (we are 60) which they would inherit when we die at an assumed age of 100 (yoga/luminosity/veggies…) Assuming an annual tax bite of 2%, our annual net return would be 5%. At this rate, money only doubles every 15 years (72 divided by 5). If we start at the same $70,000 in 10 years (a simplifying assumption) at Cam’s age 30, the first doubling to $140,000 is not reached until he turns 45 and $280,000 is not reached until he is 60.  The price of ongoing tax is 1 less doubling. Cam would inherit only $280,000 in a taxable account versus $560,000 in a tax-free ROTH.

Note that under the “keep it under our control” scenario we could have invested in buy and hold equities paying something less than 2% per year in taxes (taxes on dividends and rebalancing still add up) and they would get a step-up in basis to mitigate tax on appreciation. We thought it critical however, to have an investment program actually under their control. The idea is to compound $ and compound their financial education!

The rest of the plan – Cam still has another 10 years to work and even though we check out at age 100 his ROTH doesn’t. The $560,000 grows to $1,120,000 by age 70. With an annual drawdown rate of 4.5% our $50,000 contribution, generates $50,000 per year during those twilight decades.
Don’t grimace at your child’s first W2 – open up a ROTH!

Notes: Sustainable retirement drawdown rates of between 4 to 5% are often quoted in our industry. With inflation at 2%, prices will more than double by the retirement date. Perhaps the title should be “Our 50/25 Plan” given the reduced purchasing power. If 2% is low for inflation, hopefully 7% is low for a return assumption. In any case, the spread between the two, seems reasonable to us.


[Editor’s Note: Mr. Frank’s plan is the basic “daddy match” plan that has been advocated in various places. For example, teenagers with a job can put 100% of their earnings (up to $5500) into a Roth IRA (and beyond that into a taxable account) if daddy provides a 100% match for them to spend. They get their cake and can eat it too. If you wish to start retirement savings for your children prior to them earning any money, you can use a low-cost variable annuity as advocated in the book Make Your Kid A Millionaire. The decades of tax-protected growth should outweigh the additional costs of the VA. These are far better plans than buying them a stupid whole life policy which many people are suckered into doing. I also love Mr. Frank’s plan to both provide an inheritance early (when it is more useful) as well as providing the more valuable inheritance of financial knowledge. The plan also displays the value of multi-generational financial planning when the family is not dysfunctional. Imagine if that Roth IRA that dad funded was left to kid’s great grandkid and stretched over another 80 years. There could be 160 years of tax-free growth.

However, while reading his post I am struck by the dilemma of paying for your children’s retirement. The Millionaire Next Door was very clear about the true cost of providing “Economic Outpatient Care.” Will the additional money provided to a 20 year old sap his motivation to really go for it career-wise and savings-wise? Whose job is it really to save for retirement? What would you say if your parents came to you and offered to give you retirement money? At this point in my life, I’d tell them to buzz off and go spend it on a cruise. At 20 with a negative net worth? Perhaps I would have taken a different tone. Despite my best efforts encouraging them to spend their nest egg, I expect I’ll probably still get an inheritance, and it would have been far more useful at 20 than 60.]

What do you think of the “daddy match” program? How much of your children’s inheritance will you be giving prior to death? What do you do to instill good financial habits in your children? Comment below!