Generational Wealth for Children
Welcome to the Schmoozeletter Blog. Your source for weekly water cooler wisecracks from the world of finance. If you have an opinion different than mine or a topic you want to hear about, let me know!
This week, we got more pesky, sticky inflation data on Wednesday—meaning it’ll be even longer before the Federal Reserve can cut interest rates. Punxsutawney Fed says:
SIX MORE MONTHS UNTIL RATE CUTS
Meanwhile, Elon Musk continues his quest for world domination.
The most ridiculous part of this headline? OpenAI, the creators of ChatGPT, is still legally a nonprofit.
But enough mumbo jumbo—let’s make your kids rich.
I’m talking generational wealth. I’m talking should we vacation in Monaco or Versailles level rich. I’m talking when I bought that Aston Martin, y'all thought it was rented level rich. I’m talking extra protein, add the queso AND the guac at Chipotle level rich.
How much does it cost to set your kids up like that? Probably less than you think.
But I’m not one to bury the lede.
In the right tax accounts, invested in the right funds, almost entirely tax-free generational wealth for your kiddo can be reached if they make:
$7k per year.
Is it step-by-step guide time? Feels like step-by-step guide time.
1. Put That Kid to Work.
Step one is the only step that takes a bit of accounting. Your child needs EARNED INCOME. They need TAXABLE INCOME that is earned from a real business.
You may be thinking, “What can a baby do to earn income?”
Very simple answer: model.
The easiest and simplest way to do this is a picture posted on the Instagram of a legitimate business. The business pays the child an advertising expense for their hard work of sitting in good lighting, and voila: EARNED INCOME.
But who has a business that you could pay for services to guide you through the financial planning of your child’s life? A business that would pay them for advertising and issue the appropriate tax forms for your child, providing the TAXABLE INCOME they need?
If only you knew a devastatingly handsome CPA who writes the world’s number one comedic weekly newsletter on financial topics.
2. Put That Money in a Roth IRA
Now that your kid has money, you want to put it in an account where it can grow tax-free. You want to put it in an account where the distributions in retirement are tax-free. You want to put it in a Roth IRA.
Remember, this is taxable income just like the kind you get every two weeks from your employer. You and your child worked the same level of difficulty for this income in the eyes of the IRS.
After-tax money means they will file a tax return at the end of the year, but their income is so small they will pay little to no taxes. Then, once it is in the Roth IRA, it is tax-free for the rest of their life.
3. Invest That Money
Putting the money in the account is only half the battle. Now, you need to choose the right investments.
You are going to want an investment that is low-cost with minimal fees.
You are going to want an investment that is passive so you don’t need to constantly check in on it.
You are going to want an investment that objectively reindexes so it’s still around in a hundred years or a hundred lifetimes.
You are going to want an investment that pays cash so once the portfolio is large enough, your kiddo can live off the interest without ever needing to touch the principal.
You are going to want a dividend growth index fund.
4. Do Nothing
For some, this will be the hardest step.
Let’s go over two scenarios:
Scenario A:
1. You get your child earned income of $7K per year for their first ten years.
2. You accidentally forgot step 3, and the money has been sitting in cash the whole time.
3. You finally invest the cash at ten years old and let it sit until the kid’s retirement age of 60.
4. You or your child never contribute another dime to the Roth IRA.
So how much could that $70K be generating for your 60-year-old?
$1,377,079.97 per year.
You read that correctly. The IRA could be generating $1.3M per year in cold, hard cash. That isn’t the value of the portfolio—that is the cash. That is the amount they could live off per year without touching the principal.
It’s a little bit hard for us to fathom just how powerful fifty years of compound interest is. Now, $1.3M in sixty years isn’t like $1.3M today. Inflation will eat away at it. But still, assuming a 2.5% inflation rate, that is the equivalent of over $300,000 in today’s dollars.
Would you be alright with a $300K tax-free salary right now?
Scenario B:
1. You get your child earned income of $7K per year for their first 18 years.
2. You remember to invest this time from day one.
3. You’ve taught your child good money habits, and they continue to contribute $7K per year to the Roth IRA through their adult life.
So how much could that portfolio be generating for your 60-year-old?
$3,617,147.06 per year.
Yup. The IRA could be generating $3.6M per year in cold, hard cash. That isn’t the value of the portfolio—that is the cash. That is the amount to live off per year without touching the principal.
Assuming a 2.5% inflation rate, $3.6M is the equivalent of over $800,000 in today’s dollars.
Think your little one could manage with an $800K tax-free salary?
The most powerful investment tool is:
TIME.
Final Thought
"Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn't, pays it." – Albert Einstein
