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Gifts With Interest

Larry Sayler

FOR 10 YEARS, my wife and I have given each of our four children $5,000 to $6,000 per year for them to put in their respective Roth IRAs. So far, we have given each of them about $60,000.

They were amazed a few years ago when their investment gains for that year exceeded our annual contribution. Today, their Roth accounts are now each worth about $125,000, so their cumulative growth—about $65,000—now exceeds our total contributions.

We began in March 2012, when our four kids ranged in age from 23 to 31. We gave each of them $5,000, which was categorized as a 2011 IRA contribution. That December, and each subsequent fall, we gave them another $5,000 to $6,000, depending on IRA contribution limits. From the start, the money has been 100% invested in total stock market index funds.

We love our children. They’re great kids—caring, hard-working, creative. But 10 years ago, none had a high-paying job. They weren’t interested in financial matters, probably because they had little money. In the beginning, my wife and I told ourselves we would give them money for at least three years.

Legally, once the money is in our kids’ accounts, it’s theirs. They can do what they want with it. My wife and I view it as their retirement funds, however. To receive our contributions, they must allow us to view their accounts online. We’re very clear. If they withdraw money early, they’ll get no more deposits from us.

We set up these Roth IRA accounts at Vanguard Group, where we had our investments. I did most of the setup work, although our kids did have to complete some paperwork. Recently, we moved our accounts, and our kids’ accounts, to Schwab. At either place, the annual transfers have been easy. We simply transfer money from our accounts to our kids’ accounts.

We have had two major bumps along the road:

  • Lack of earned income. People can put money into a Roth IRA only to the extent that they or their spouse have earned income. Two of our children have had years with no earned income. For those years, we opened a non-IRA account in their name and put the money in that. Of course, this money does not grow tax-free.
  • One of our children is facing divorce. We realize that half of their IRA may go to that child’s soon-to-be ex-spouse. We’re okay with that. We like that person and we are sorry for their divorce.

By making contributions, we hope our kids will learn something about investing and the financial markets. I especially hope they embrace two crucial lessons.

First, U.S. stocks are a good place to invest in the long run. I don’t know what will happen during the next 60 years, but I hope the U.S. stock market will continue to be a good place to invest during our children’s lifetimes.

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Second, during a market drop, they shouldn’t panic and sell everything. There has been only one year, 2018, in which their accounts have shown a loss, and that was a loss of just 8%. I wish we had a few years with greater losses. I want them to realize that, for a long-term investor, a significant loss is not a time to panic.

My wife and I plan to continue contributions indefinitely. In another 10 years, with additional annual contributions and reasonable growth, their accounts should be worth $250,000 each. If my wife and I are fortunate enough to be alive 20 years from now, their accounts might be worth $500,000 each. That will be $2 million that otherwise would have been in our estate.

I’m concerned about estate taxes. For 2022, federal estate taxes do not kick in unless a person’s estate is more than $12 million. We are well below that amount. In 2026, if Congress does nothing, the threshold will drop to about $5 million. But Congress can change this exemption amount at any time. We would much rather give our money to our children and charities than to the federal government.

Each year for Christmas, we give our children a nice card with a letter and a spreadsheet. The spreadsheet shows, for each year since we began the program, their beginning-of-year balance, our contributions, their investment gains or losses, and the end-of-year balance. I want them to see the big picture of the progress their account has made.

My wife and I can do this for our kids because we have accumulated a nice nest egg. We are not wealthy, but our needs are modest. Our portfolio continues to grow, and we are withdrawing just 2% to 3% each year. We use withdrawals for these transfers to our kids and for the taxes associated with some significant IRA conversions that we’ve been making in recent years. Otherwise, we pretty much live on just Social Security and a small pension.

There’s a saying that, “The best time to plant a tree was 20 years ago. The second best time is now.” Perhaps we should have started this program earlier. We’re glad we didn’t wait any longer.

Larry Sayler is the only person with a Wharton MBA who also graduated from Ringling Bros. and Barnum & Bailey’s Clown College. Earlier in his career, he served as CFO for three manufacturing and service organizations. For 16 years before his retirement, Larry taught accounting at a small Christian college in the Midwest. His brother Kenyon also writes for HumbleDollar. Larry’s previous article was Making a Difference.

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David Malone
David Malone
3 months ago

Larry, I’d be interested in understanding more about why you moved your accounts from Vanguard to Schwab.

MikeinLACA
MikeinLACA
3 months ago

In the new “gig” world, fewer and fewer young people work for employers that offer 401(k) benefits. Setting up Roth accounts is surely the way to go for them. I started matching my kids’ afterschool job earnings when they were in high school as Larry did for his older kids. Now that they’re in their 20s, they’re much more financially literate than many of their friends – simply because of our once-a-year discussion about this. Unexpected benefit!

ostrichtacossaturn7593
ostrichtacossaturn7593
3 months ago

Not sure what state you live in or what the property rights and gift laws are, but in my community property state of Texas a gift — even to a married person — remains the separate property of that donee (the person who received the gift from the donor) as long as they keep it segregated enough to “trace” the original gift. Sounds like that’s fairly easy to accomplish in the Vanguard or Schwab accounts where you’ve made your matching contributions, and checked online annually.

It’s certainly commendable that you don’t mind your ex-son-in-law getting half of all the gifts you made to your daughter (and I’m assuming they were only to your daughter and not to them as a couple). But I’d check in with a good divorce lawyer who knows the applicable property and gift laws in the state of the divorce before assuming that is the case.

Donny Hrubes
Donny Hrubes
3 months ago

YES! I started this program with my two son’s who are now men with families of their own. I gift them both $5000 a year to be deposited in their own Roth accounts in TD Ameritrade. They have the option of contributing more, but that is their choice. They’ve been shown an online calculator to see the difference it would make, which is quite a bit. It’s opened a window to the investing game which they are learning.

I have turned on my own Roth distributions, and that almost covers the gifts in whole. It’s a good way to inherit those funds now, not when I pass.
My Roth funds are deposited in a trust that holds real estate and the income from it and when my Roth distributions stop, the gifts keep continue until they choose to take their own distributions.

We want the best for our children, thinking of wealth transfer is an important part of parentdome! 😉

Kirk Dawson
Kirk Dawson
3 months ago

We have adopted a similar path as others have shared.

Matching IRA contributions.

Roth for our saver, Regular IRA for our spender.

one side benefit is it allows us to open conversations about investment choices and long term planning.

We also involve both “kids” on our charitable giving. We walked them through why we set up a Donor Advised Fund, and we jointly select who we support with donations each year.

Jim Wood
Jim Wood
3 months ago

I too built a Roth portfolio for my son and kept very accurate records. When he was divorced after 10 years of marriage, he was able to retain the entire Roth IRA portfolio because it was built totally from gifts from me. I was very careful to not allow any community property money be used for his Roth IRA. Consequently, the entire Roth IRA was considered separate property via gifting and he was able to retain the complete Roth IRA in the divorce. This happened in Florida which is a community property state and every state is a bit different.

The rest of the story is just sad. He withdrew the majority of the Roth IRA to pay legal fees in an attempt to get custody of his three children. And I lost my grandchildren to the divorce.

Donny Hrubes
Donny Hrubes
3 months ago
Reply to  Jim Wood

WOW Jim, That’s so sad how things turned out. We have hopes for our kids. But, as we know, nothing is set.
Tomorrow is not guaranteed. But, we still try regardless.
Bless you for doing that.

Will Wiener
Will Wiener
3 months ago

I can certainly understand why parents
would be motivated to employ this type
of strategy.
But I have never seen an analysis of
the impact of Roth accounts on future
government revenue streams but i
am concerned they could be quite
significant.

Also, I believe that the purpose of Roth’s
was to incentivize savings in taxpayers
who were not in high income brackets.
Do not think they were intended to
support wealth transfers in high net
worth households. We have the annual
Gift tax exclusion and other estate planning
techniques for that.

Of course, affluent parents can give gifts
that can be used for living expenses, freeing
up cash for a Roth so this can get complicated.

If the government loses too much revenue to
Roth’s, we could end up with another long
term fiasco like student loan debt which we
should avoid.

Chris Sciora
Chris Sciora
3 months ago
Reply to  Will Wiener

You’re right about high earners being excluded. That’s why there’s an explicit income cap for making Roth IRA contributions (despite the availability of Backdoor Roth contributions). However, it’s been almost fifty years and Roth IRAs still hold only a tiny fraction of total retirement assets. In this particular case, it also sounds like the Roths are being funded with relatively high-tax dollars which is good news for the government.

https://monosnap.com/file/u3STpz7h9nB0DipBq4WeuCBycvchT3

Personally, I love this strategy along with using Roths for active business investments. My young kids (12 & 10) have shiny new Roth IRAs with a bit of money invested. Next step is putting together enough earned income to make them worthwhile over the next ten years.

Will Wiener
Will Wiener
3 months ago
Reply to  Chris Sciora

Not sure how you came up with 50
years – Roth IRA’s passed Congress
in 1997, I believe.

Larry Sayler
Larry Sayler
3 months ago
Reply to  Will Wiener

I agree that Roth legislation “was not intended to support wealth transfers in high net worth households.”  Yet that is exactly what we are doing. 
 
If our plan ever became widespread, legislators might pass new rules outlawing what we are doing.  I am confident our plan will never become widespread.  Most people don’t have the assets available to give their children $6,000 per year.  Even among moderately high net worth people (assets of $1 MM to $10 MM?) most people are hesitant to do this because they have a fear of “running out.”  It seems to me that these concerns are often irrational, but maybe I am wrong.
 
I do like the idea of matching what your children put in their Roth IRA, as Randy Dobkin suggested.  That ensures that they have some skin in the game, and reduces the amount that must be transferred from the parent.

Billy McKelvy
Billy McKelvy
3 months ago

Great article. My wife and I have been maxing out Roth IRAs for our two children since we retired and cant add to our own IRA accounts. Our children are not interested in money matters now but I believe in the future they will be glad we took care of it for them.

Ben Rodriguez
Ben Rodriguez
3 months ago

That’s terrific! I dream of doing the same with my kids (who are now very young). I like your perspective about divorce too. In my father’s culture, a divorce does not end the relationship of the non-blood spouse and their former “in-laws.” You’re always just family.

Randy Dobkin
Randy Dobkin
3 months ago

We matched our kids’ Roth IRA contributions until they had their own 401(k) plans, so they had some skin in the game.

Larry Sayler
Larry Sayler
3 months ago
Reply to  Randy Dobkin

Excellent idea. We will seriously consider switching to this approach.

Andrew Forsythe
Andrew Forsythe
3 months ago

Very thoughtful and well designed plan. Your kids are lucky—they’re benefiting both from your generosity and also from the financial education you’re providing.

steveark
steveark
3 months ago

It’s just my opinion but I think the main lesson you may be teaching them is that they don’t have to worry about having their own retirement plan because you are their retirement plan. Which is fine, I suppose. I inherited 7 figures from my parents but by giving it to me only after their death, when I was nearly at retirement age, I knew I’d have to have my own plan, which I did.

Larry Sayler
Larry Sayler
3 months ago
Reply to  steveark

You point out a very valid reason for not doing such a plan. We did think about this. When we started our plan, none of the four were saving for retirement. Now that they are in different jobs, and perhaps because they are older, three out of the four are participating in their employers’ 401(k) or similar plans.

Some people may not want to implement what we are doing exactly because of the reasons you raise. We are comfortable with what we are doing, and in our situation we believe it makes sense.

Larry Sayler
Larry Sayler
3 months ago
Reply to  steveark

(My comment got posted twice. I have deleted the duplicate post. Sorry.)

Last edited 3 months ago by Larry Sayler
R Quinn
R Quinn
3 months ago

I understand your goals and share them. We gave most of our last RMD to our four children and grandchildren and each month we contribute to eleven grandchildren’s 529 plans. We live on a pension and SS – the SS is used for travel. We only take from investments because of the RMDs and all growth is reinvested.

I see you live on SS and a small pension with modest needs. What I hear is you may be living close to the bone income wise because you want to help your children. That’s commendable, but do your plans take a long term view of your and your wife’s lives for the next 20 years or so – when needs may not be so modest or are at least unknown?

Larry Sayler
Larry Sayler
3 months ago
Reply to  R Quinn

Good observation and I can see why my article implied that. But that is not the situation. In fact, quite the contrary.

We have investments in the low to mid seven digits (plus fully paid for home and vehicles). The investments are all in Traditional and Roth IRAs. We do not yet have any RMDs. Our investments generate lots of income, but none of it is taxable. Right now, we have been doing some conversions from Traditional to Roth IRA. We have to take money out to pay taxes on those conversions.

We do not believe we live “close to the bone.” We have taken numerous overseas trips. We do what we want. But we don’t need the latest and greatest anything. (Our two vehicles are both 17 years old, and both have just less than 100,000 miles. Another long story.)

We are quite comfortable that we have enough to meet all our future needs.

Last edited 3 months ago by Larry Sayler
Will
Will
3 months ago
Reply to  Larry Sayler

I enjoy looking at the ‘UP’ votes on comments to see which opinions are shared by the readership, relatively. I’d say the readership appreciates common sense and restraint (financially).

R Quinn
R Quinn
3 months ago
Reply to  Larry Sayler

Thanks for your reply. I better understand your situation. The tricky part is when someone talks about their “needs” because that has such a wide range of possibilities. Our needs include a lot of travel too – well it did until 2020 and hopefully will again. The travel need has switch to a remodeling need.

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