Investing for Your Kids

Some Sample Comparisons

Investing for Your Kids

Let's look at some sample scenarios to see what might be the most efficient ways to save.

First let's lay out some assumptions. These will hold steady across the various scenarios, so we'll be comparing apples to apples. We're going to calculate the after-tax value of your (or your children's) investments at age 59 1/2 (the age of retirement). We'll assume that you make your $2,000 contribution each year. For the regular IRA, of course, you get tax savings each year; we'll assume you invested those and earn the same return that your IRA is getting.

We'll put you in the 31% tax bracket while you're working, and the 15% bracket after you're retired. This means that you're investing $620 of tax savings per year (31% of $2,000). And for simplicity's sake we'll assume that those earnings will be included as income for that year, and taxed accordingly -- we'll tax them at your income rate, not the capital gains rate.

OK. Now, let's say you're 28 years old, and that you're going to get an 11% return on your IRA investments. This is about in line with the historical returns of the S&P 500, so it would approximate your investment if you chose to have it in an index fund.

If you'd put your money into a regular IRA, you'd have $494,850 heading into retirement. If you'd invested that money in a Roth IRA, you'd have $492,647. Not much of a difference. But if you'd invested that same money in a nondeductible account, you'd have $428,050 -- about $65,000 less.

If we take the same scenario, but start it earlier, from age 15 -- about when your child might be getting earned income, and so could have an IRA of her own -- the numbers favor the Roth IRA. Your child would have $1,971,270, versus $1,886,520 from a regular IRA -- a difference of about $85,000. Again, let us note the power of compounded returns over time.

How about if you'd invested that money in a nondeductible account? You'd have $1,688,780. Nothing to sneeze at -- but almost $200,000 less than the traditional IRA, and over $282,000 less than the Roth IRA. Those savings are nothing to sneeze at, either.

Why not teach the little ones a thing or two about investing while you're saving for their future? Next, we show you how.

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