Was it really only a few short months ago that we were worrying about the fiscal cliff and sequestration? It seems that, while we as a nation continue to find ourselves settling into the “new normal”, the more things change the more they stay the same.
Today the average savings of a 50 year old is only $43,797 and 80% of people ages 30-54 do not believe they will have enough money put away for retirement (http://www.statisticbrain.com/retirement-statistics/). These unfortunate statistics illustrate how a majority of Americans are unprepared for retirement. An early start to savings in a retirement account is not only an important leg-up to beginning to build financial security, but also a valuable learning opportunity. Unfortunately, teenagers with part-time jobs and even young adults in their 20’s & 30’s are often hard-pressed to commit to saving towards their retirement goals due to cash-flow issues. The good news is that, as long as they have earned income, you can gift to Roth IRAs on their behalf; a gift that will continue giving.
In 2013, the amount of money you can directly give another person without incurring a gift tax is $14,000. These annual gifts are a tool for parents and grandparents who want to transfer wealth to younger generations of their family as tax efficiently as possible, and are most often donated to the beneficiary’s taxable accounts. When the gift is used to fund Roth IRAs, any growth in the account, as well as withdrawals, are sheltered from income tax as long as the IRS guidelines are followed. For younger beneficiaries, this is a good way to start saving for retirement since they have so many years ahead of them for their money to grow.
The primary limitation for this strategy is that the child or grandchild owning the Roth IRA (or if married their spouse) must have some earned income (W-2, Schedule C, etc.). The Roth owner must also have total income under certain thresholds in order for a contribution to be made directly to a Roth IRA account (it should be noted that there are some loopholes for contributions to Roth IRAs for households that earn in excess of the AGI limits). In 2013, the limitations are as follows:
Assuming IRS guidelines are followed, withdrawals from the account in retirement are 100% tax-free. While there is no crystal ball telling us what the federal tax system may look like next year, let alone decades from today, it is hard to imagine an environment when tax-free income would lose its appeal.
Even one gift to a Roth IRA has the potential to make a meaningful difference for the beneficiary’s retirement. A $5,500 gift today, assuming a 6% annualized return, would be worth more than $56,000 in 40 years. If the $5,500 gift is made for 5 consecutive years, it would be worth over $250,000 in the same time frame (again assuming a 6% annualized return). And all of these funds are available tax-free.
Beyond tax-free growth, Roth IRAs have additional benefits. For example, they are not subject to required minimum withdrawal rules that apply to Traditional IRAs beginning the year after you turn 70 ½. In addition, funds are also available for withdrawal:
- Once you have reached age 59½
- 5 years after initial contribution is made (only contribution amount – excludes earnings)
- If you are permanently disabled, you are the beneficiary of a deceased IRA owner, or you use the distribution to buy, build, or rebuild a first home (up to $10,000)
- If you have unreimbursed medical expenses that are more than 7.5% of your adjusted gross income
- If you are paying medical insurance premiums during a period of unemployment
- If the distributions are not more than your qualified higher education expenses
- If the distribution is due to an IRS levy on the qualified plan
- If the distribution is a qualified reservist distribution
While you may never see “contribution to Roth IRA” on a holiday or birthday wish-list, it is certainly a gift that will last and continue to give.