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Financial Planning Tip November 2023

Roth IRA makes a great gift

Most of our clients are aware of the difference between a traditional IRA and a Roth IRA. The former grants an up-front tax deduction (but withdrawals are taxed) while the latter lacks a tax deduction (but withdrawals are tax-free). The ideal candidate for a Roth IRA is someone who is in a low tax bracket today and who is also young enough to enjoy many decades of appreciation in their IRA. To put it bluntly: someone in their teens or twenties in a low-paying, entry-level job. Therein lies the catch: young people working entry-level jobs often lack the money, discipline, or both to contribute to a Roth IRA.

That's one reason why we think Roth IRAs make a great gift. Any relative can contribute to a young person's IRA. The normal stipulations apply. For example, the recipient must have earned income and can't contribute more than the $6,500 limit in 2023. Other conditions exist, and you'll need to coordinate with the recipient each year to ensure they're still eligible. 

The effects can be extremely powerful. A 17-year-old who receives ten years of $1,000 gifts will see those funds appreciate to nearly $500,000 by age 70 if the market returns an average of 8% per year. (It's returned close to 10% per year over the past two decades.) Meanwhile, someone who starts saving $1,000 per year at age 27 -- and makes ongoing contributions until retirement -- will have 20% less money at age 70 assuming the same investment returns.

The gift of a Roth IRA may sound like a dusty shoe box of savings bonds from Grandma, but the impact can be immense. The earlier the young people in your life can start, the better.


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