You can give your loved ones an incredible gift -- of financial security. Photo: m01229, Flickr
Many of us are a bit more focused on ourselves than we should be. For example, we may be saving and investing for our retirements, hoping to have a useful sum left over for our children when we die. We can do better than that, though. With a little foresight, we can make our kids -- or, more assuredly, our grandkids -- wealthy.
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The miracle of compoundingThe way to wealth for most of us is through compounded growth -- as our nest egg grows by bigger and bigger amounts each year (roughly). The three main levers in the compounding engine are the money that's invested to grow, the average rate at which it grows, and the time in which it's left to grow.
For many people, it's not until they're in their 40s or 50s that they start thinking seriously about retirement plans, and start socking away money. That only gives them about 10 to 25 years for their money to grow, though, which means they will probably have to sock away a lot of money in order to accumulate a meaningful nest egg.
Growing money for kidsThe situation is different, though, when it comes to your descendents. Imagine, for example, that you're 45 years old, and have a 15-year-old daughter. You might only have 20 years until you retire, but your kid has 50 years until she hits the big 6-5. Check out what happens to a single $10,000 investment over several decades, if it grows at the stock market's long-term average annual growth rate of close to 10%:
Your investments might not average 10% over your time period, but you can aim for that via a simple, low-cost broad-market index fund, such as the SPDR S&P 500 ETF, Vanguard Total Stock Market ETF, and Vanguard Total World Stock ETF. Respectively, they distribute your assets across 80% of the U.S. market, the entire U.S. market, or just about all of the world's stock market.
Photo: Laurence, Simon, Flickr
Imagine how nice it would be for you to hear that a grandparent socked away some money for you decades ago. That might make you suddenly able to retire early! You can do the same for your kids -- whether they're born or not yet born, whether they're 5 or 15 -- and even for born or unborn grandchildren. The longer you let a modest sum sit and grow, the bigger it will get. If you just invest $5,000 once, you can still grow $1.5 million over 60 years.
Making it realLet's consider inflation now, for a minute, because over very long periods, it can significantly diminish the purchasing power of your money. It has averaged about 3% over the long run, so let's change our hypothetical growth rate from 10% to an inflation-adjusted 7%. Here's the table above, revised:
The numbers are considerably smaller, but still sizable. Imagine receiving a gift of $150,000 or $295,000 from a parent or grandparent while you're still in your 40s or 50s. That can be a life-changing sum, greatly enhancing your retirement or bringing it on sooner.
Several generations might benefit from your generosity. Photo: MoodBoard, Flickr
Being tax-smartA final consideration is how to minimize taxes when saving money for descendents. One strategy is to save in a Roth IRA, from which withdrawals will be tax-free. If someone other than your spouse inherits it, they will have to start taking required minimum distributions (RMDs) based on their life expectancy, but the withdrawals will be tax-free. If the Roth's contents go to a very young person, the RMDs will be very small, leaving most of the account to keep growing and providing a little welcome income.
You might also look into trusts, which can be tax-smart ways to pass money on to the next generation or even to skip a generation. Consult a financial professional about this, and read up on the matter, as there are many kinds of trusts and ways that they can be set up.
So go ahead and do save and invest for your own retirement -- as Social Security alone isn't likely to deliver the comfiest retirement. Also give some thought to setting up a welcome windfall for your young loved ones, though -- and future loved ones, too.
The article Heres How to Make Your Kids or Grandkids Wealthy originally appeared on Fool.com.
Longtime Fool specialistSelena Maranjian, whom you can follow on Twitter,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.
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