When you have a newborn baby, planning for your child’s retirement may not be at the forefront of your mind. But the reality is, you can make life a lot easier in the future for your new bundle-of-joy if you give a little bit of thought to this issue as soon as possible after birth.
If you want to help set your child up for a lifetime of financial success, follow this advice from three Motley Fool retirement planning experts about how you can begin retirement planning for a newborn during their first years of life.
Research Roth IRA contribution rules so your child can contribute to a Roth ASAP
Christy Bieber: A Roth IRA is a fantastic retirement savings account for people who start young. That’s because you can contribute to this account with after-tax dollars in exchange for tax-free growth and tax-free withdrawals.
If your child contributes to a Roth IRA when their tax rate is low (or when they have such a low income they won’t pay taxes at all), they won’t have to worry about missing out on the upfront tax breaks that traditional 401(k)s and IRAs offer. And, they can start their money working for them right away.
The money your child puts into a Roth will grow without any capital gains taxes. And once they retire, they can withdraw the money tax-free too. With many, many decades of compound growth, even small contributions to a Roth IRA could leave your child a millionaire many times over by the time their retirement age rolls around.
Now, your child does need earned income to contribute to a Roth IRA, so it’s unlikely they’ll be able to start making investments in this account as soon as they are born. But as soon as they begin earning money, you can open one for them and they can contribute to it.
Research the rules or talk with a tax professional about how to help your child invest earned income in a Roth and then purchase safe investments such as an S&P 500 ETF that will allow your child to build a huge tax-free nest egg they can withdraw from in retirement.
Open a brokerage account
Maurie Backman: The tricky thing about retirement planning for newborns is that you can’t just open an IRA on their behalf. You need earned income for one of those plans, and, well, most newborns clearly aren’t there yet.
But one thing you can do is start investing on your baby’s behalf in a brokerage account. If you start buying quality stocks when your child is first born, you’ll give that money a lot of time to grow. Then, as your child gets older, you can add stocks to that account together so that your child learns to pick stocks and why it’s important to stay invested in them for the long haul.
Eventually, you can transfer that brokerage account into your child’s name once they turn 18 (or 21, depending on which state you live in). And from there, your child can add to that account and/or hold those stocks so they serve as a retirement nest egg.
Of course, having that financial start could put your child at a huge advantage when it comes to retirement savings. Many people don’t accrue so much as a dime for retirement purposes until they go out and start earning wages in their late teens or 20s.
But what may be equally instrumental to your child’s success on the retirement savings front is having the knowledge to research and evaluate stocks. And while your baby’s first words don’t have to be “P/E ratio,” the sooner you get your child on the right path, the better.
Open a 529 plan
Katie Brockman: A 529 plan is a tax-advantaged investment account specifically for college savings and other education expenses.
Anyone over the age of 18 can open a 529 plan, and anyone of any age can be an account beneficiary, making this a smart option for parents looking to save for their children’s future college tuition. When your child has less debt heading into adulthood, it can make saving for retirement far easier.
Contributions to a 529 plan are generally tax-deductible, depending on what state you live in, and withdrawals are also usually tax-free as long as the money goes toward qualifying education expenses. Withdrawals for non-education expenses are allowed with this type of plan, but you could face penalties and income taxes on the amount you withdraw.
Also, when you contribute to a 529 plan, you’re investing your money rather than simply saving it. You often have a variety of investments to choose from, including mutual funds and index funds. This can help your money grow much faster compared to simply stashing it in a standard savings account.
By opening a 529 account now, you’ll have nearly two decades to let your investments grow before your child starts withdrawing that money for college tuition. If you’re earning a modest 7% average annual return on your investments and are investing, say, $100 per month, you’d have nearly $41,000 accumulated after 18 years.
Student loan debt can make saving for retirement challenging, especially as the cost of college tuition continues to skyrocket. By investing in a 529 plan now, you can help make education more affordable for your child, giving him or her a head-start when preparing for retirement.