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~Helping a Young Person Grow Wealth May Not be as Daunting as It Seems~

 

We all want the young people in our lives to be financially secure when they are older.  With the future so uncertain, this can seem like too daunting of a task to think about.  But the government has recently made this a little easier.

 

To put things in perspective, a young person investing over a long time horizon would likely want to:

1) invest in historically high-performing and volatile assets

2) get started investing early

3) take advantage of tax-sheltered accounts whenever possible

 

In order to accomplish #1 and #2 above, consider the fact that since 1972, the stock market has risen at a compounded annual growth rate of over 10%.  Adjusted for inflation, over this time period, the stock market beat inflation by over 6%.  That's still nice.  

 

This means that $10,000 invested in 1972 would be worth over $200k today after inflation.  In other words, that $10k investment would be able to purchase 20 times the amount of goods and services today, compared to what that initial $10k could have purchased in 1972.  Add some small companies' stocks to that total stock market investment and historically you'd have even more than 20x your investment after inflation.  

 

Will these results continue into the future?  Will really bad things happen that drive stock prices down?  Are stock prices already too high now?  We don't know, but we do know that a lot of very bad things have happened in the world since 1972.  So, historically, owning pieces of all of the companies in the economy has been one of the most reliable ways to build wealth over the long run.

 

 

In terms of addressing point #3 above, one of the best ways for a young person to avoid taxes is to invest through a Roth IRA, since a Roth IRA grows tax free for life.  One problem that young people face though, is that they have to have earned income when investing through a Roth.  So let's say a young person were fortunate enough to have a grandparent give them $2000.  The young person could only put this $2000 into a Roth IRA account if they had earned income from a job of $2000 (currently, up to $6500 of earned income can be put into an IRA each year).  So this can present a barrier to the young person accessing the tax benefits of a Roth IRA.

 

One way around this problem is a new law that Congress passed last year (the Secure 2.0 Act).  This law allows one to move money from a tax-free college savings account (called a 529 account) into a Roth IRA.  After a 529 account is established for 15 years, up to $35k can be moved from a 529 into the Roth as long as the individual has $35k in income, which won't be a problem once the young person grows up and has a real job.  

 

I used to worry about saving for my kids' college in a 529 (though I did it anyway) in case they decided not to go to college or they got a big scholarship or the government made college free (or cheaper), because if you don't use the money for education expenses, you have to pay taxes and a penalty on the gains.  This new law makes that less of a concern.  The other benefit of starting with the 529 is that any family member or friend can contribute to the 529 on behalf of the child - and the child doesn't need to have a dime of earned income.

 

 

So, the moral of the story is, to help a young person (or even a newborn) get started on the way to financial security, open up a 529, put in a lump sum (or make regular contributions and get free education money from the state of Maine), invest in aggressive, volatile assets over a long period of time, and then move up to $35k of the money into a Roth IRA at some point in the future.  And if the student ends up needing all or some of the 529 money for college, it can obviously be used for that purpose at any time.

 

This new law makes 529s even more appealing as saving/investing vehicles, especially for young people.

 

Here are some further resources that might be helpful:

 

-Maine's 529 program:  https://www.nextgenforme.com/

-Moving a 529 to a Roth IRA:  https://www.forbes.com/advisor/retirement/529-to-roth-ira/