Friday, November 9, 2012
RETIRE A MILLIONAIRE!
A “tweet” from GETTING YOUR FINANCIAL DUCKS IN A ROW author Jim Blankenship, an Enrolled Agent, led me to his post “How To Turn $5,000 A Year Into a $33 Million Legacy” from August of 2009.
Forget about the $33 Million. Let us look at the beginning of the example he uses (the highlights are mine) -
“Once upon a time, there was this guy named Joe. He was 20 years old, working part-time making decent money, finishing up college, just generally living large (by a 20-year-old’s definition). On the advice of his father (yes, some 20-year-olds listen to their fathers!), he opened up a Roth IRA, funding it with $5,000. The account was invested in a fixed 5% yield instrument of some sort (not important what the investment is, just assume a 5% annual yield).
Using the Roth IRA is advantageous to Joe because his tax rate is very low at this stage of his life – presumably tax rates will be increasing for him in the future. Any growth on this account is tax-deferred and most likely tax-free, as long as any future distributions are for qualified purposes.
Each year thereafter, Joe contributes an additional $5,000 to the Roth account. After he completes college, he starts working at an entry-level job. Not long after, he marries his high school sweetheart Jane, and they settle into their life. As life goes, they soon have children in their household, and even though money is tight, Joe continues to contribute the $5,000 each year into his Roth IRA. This goes on for a while.
And then… 20 years pass
At age 40, Joe launches his own business. During this time in his life, tax deductibility becomes more important to him since he’s making a lot more money and is in a higher tax bracket – and so he stops contributing to the Roth IRA.
All this time, his investments in the Roth account have been steadily growing at that fixed 5% rate – and the balance is now up to $165,329 – on 20 years’ worth of $5,000 investments, for a total of $100,000 contributed. Pretty nice, right?
Joe just sets the Roth account aside at this point, forgetting about it altogether for quite a while (other than those pesky quarterly statements). Not much happens here for a long, long time, other than compounding interest, time passing, and continued tax deferral.
… and another 50 years pass
Joe is now age 90. His business has flourished through the years, and now his children are reaping the benefits of having worked there, and now retiring. His grandchildren have taken over the business, and he and Jane are enjoying their great-grandchildren. A couple of years later, little Jolene is born, and this great-granddaughter quickly becomes the apple of Joe’s eye.
It is along this time that Joe remembers that long lost Roth IRA account. To this point it has grown to over $2 million – from that original series of $5,000 contributions that amounted to a total of $100,000.”
This is a great example of the effects of tax-free compounding. Joe has built up $2 Million that he can pass along to his beneficiaries income tax free.
Think what the account would be worth if he had continued to make the maximum annual contribution (including catch-up amounts when he turned 50) from age 40 to age 65, then retired and began to take tax-free distributions from the account. He would have a humungous retirement nest-egg for him and Jane to enjoy in their “golden years”, and still have a substantial tax-free legacy to leave to the children and grand-children.
Parents take note – when your children begin to have part-time after-school and summer jobs - if you can afford to do so - open a ROTH account for them and deposit the maximum allowed. Continue through their first few years of full-time employment after graduation until they can begin to make the maximum payments themselves.
Of course the story of Joe assumes that the idiots in Congress do not FU the ROTH IRA in the future.