Source: TaxCredits.net via Flickr.
One of the toughest parts of investing is coming up with the money to invest when you're young enough to let compound interest really work its magic. If you can get started in your 20s or even late teens, even a small investmentcan turn into an eye-popping amountin retirement. The problem is that when you're young, you're typically stuck with both an entry-level paycheck and all the start-up costs of beginning your independent life. By the time you have money, the time of easy compounding may have passed.
Continue Reading Below
To break that cycle, once you've reached the point in your life where you can free up cash to invest, you may want to take some of it to invest not just on your own behalf, but on your children's behalf, too. No matter how many years you have left to let your money compound, your children have more. Their additional time, plus a little bit of your cash, can perform a compounding miracle to help them someday reach millionaire status.
Make it a family priorityIf you're looking to help your kids get on the right track to a lifetime of investing, one of the most powerful approaches you can consider is to provide a matching gift for their IRA contributions once they start working for pay. The matching gift concept is important because it makes saving and investing their priority, too, not just something Mom and Dad saymight be a good idea.Investing in an IRA allows the money compound much more efficiently due to tax advantages, but it does mean your child needs enough earned income to cover the total contributions.
Saving and investing successfully takes discipline, and the potential reward of a matching gift can motivate your kids set to learn that discipline by investing regularly. By offering to match your children's contributions, rather than make contributions on their behalf, youreward yourkids for taking on the responsibility of saving a significant amount of their income.That is the foundation to any financial success they'll have in life. And by contributing money along with them, you're helping money work for them early in life, when compounding can do them the most good.
What are the rules around this?You can give any other person (including your children) up to $14,000 in gifts each in 2015without triggering any taxes or paperwork. People who are under age 50 with earned income (or married to someone with earned income) are able to contribute up to $5,500 in their IRAs in 2015. So as long as your children are earning at least as much as your combined IRA contributionsand you're not making other substantial gifts to them this year, you should be well within the rules.
Additionally, once you've completed your gift to your child, that money becomes theirs. If they decidenotto contribute the money to an IRA or to withdraw it early despite the potential taxes and penalties,then that's their choice. Hopefully, though, your child understands the benefits of the saving habits they had to adopt to come up with the money for their part of the matched investment. If that's the case, early withdrawals become a lower risk.
What are the potential benefits?Imagine that on every birthday from your child's 20ththrough 29th, you make a matching contribution that helps bring the total he or she contributes to an IRA to $5,500 for the year. Then that child of yours never invests another dime and doesn't tap the IRA until age 70. That's 10 years of contributions and 40 years of compounding after that. The table below shows the incredible potential benefits of those early 10 years of investing:
Source: Author's calculations.
That's right: It's entirely within the realm of possibility that your child could end up a multimillionaire in retirement, simply because you helped with a few matching gifts to an IRA early on in their lives. That might well be the most incredible gift -- and legacy -- you could possibly leave your family. The stock market provides no guarantees, of course, but 10% annual returns are about in line with the market's long-run rate of return,so that nearly $4 million total may well be within reach -- especially if your child continues investing throughout their lifetime.
The gift to your children that keeps on givingBetween learning financial discipline early and having several decades for your investments to grow, your child can see amazing benefits from matching contributions to their IRAs. If you've passed the stage in life where compounding can work miracles for you, consider what it might be able to do for your children. A moderately sized gift today can turn into a substantial sum of money that can enhance your family's future for generations to come.
The article Help Your Kids Retire As Millionaires originally appeared on Fool.com.
Chuck Saletta has 4 young kids, but none of them have earned income yet and thus can't contribute to their IRAs. Chuck has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
Copyright 1995 - 2015 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.