If current income restrictions associated with Roth investment retirement accounts (IRAs) prevent you from using one for your own planning purposes, chances are you are in the asset bracket that needs to think hard about not just investment management, but future estate planning as well.
It's a good problem to have, particularly because one of the most significant benefits of the Roth IRA can be realized when it is used as an inter-generational wealth transfer tool.
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For the next generation, time plus modest regular savings can equal significant wealth accumulation. One of the main contributors to successful asset accumulation is time--the more of it you have, the better the result. That's why setting up a Roth IRA for the next generation when they are still children can be one of your best long-term planning strategies. When investment compounding has upwards of 50 years to run its course, even a relatively modest savings rate can produce substantial wealth.
There are no minimum distributions required for the Roth IRA holder. Moreover, unlike traditional IRAs, minimum distributions are not required from Roth IRAs once the owner reaches age 70 1/2. Therefore, a child theoretically could have held a Roth IRA his or her entire life, never having tapped into it, and then pass it on to his or her beneficiaries upon death.
At this point, the account would fall under the same minimum withdrawal rules that pertain to traditional IRAs. However, beneficiaries may choose to string out those withdrawals over many years, continuing to earn tax-free income on the remaining account balance.
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How do you get started?
There is no minimum age requirement for opening a Roth IRA, and many IRA providers will open accounts for minors. In most cases, the only real issue is whether the child has taxable earned income. Fortunately there is no requirement that the same "earned income" is the money that funds the IRA. If your child earned income from a summer or part-time job, but then spent it, there is no restriction on using money provided by parents to establish and fund the IRA account.
You can contribute up to $5,000 to a Roth IRA in 2011 as long as your child earned at least that much. Contributions cannot exceed your child's income for the year.
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Contributions to a Roth IRA are not tax deductible, but earnings are never taxed provided your child meets the distribution requirements--most importantly waiting until at least 59 1/2 before tapping the account.
While he or she probably cannot imagine ever being that old, there are other ways to put Roth IRA savings to good use prior to age 59 1/2, such as the purchase of a first home.
One key caveat: The value of the Roth IRA is its exceptional growth potential. If heirs decide to spend or withdraw Roth IRA assets immediately upon inheritance, the Roth's strategic value as a wealth transfer tool is lost. However, if they choose to let the Roth IRA continue to grow and only withdraw what is required by law each year, the true power of the Roth IRA can be realized, and your heirs will have many reasons to thank you for your providence and foresight.
Doug Lockwood , CFP is a Partner at Harbor Lights Financial Group, a full service wealth-management team that has been dedicated to assisting clients in the accumulation and preservation of their wealth for over eighteen years. He was recently named one of America's Top 100 Financial Advisors by Registered Rep Magazine (August 2010) based on assets under management.
Doug Lockwood is a registered representative with and securities offered and advisory services through LPL Financial, a Registered Investment Advisor, Member FINRA/SIPC. For more information, go to www.hlfg.com.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial adviser prior to investing.
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