There’s plenty of stressful news these days, and by and large I’m used to hearing or reading about unpleasant developments.
But I was particularly alarmed by a report this fall that Congress was considering drastic cutbacks in the contribution limits to 401(k) and similar retirement plans.
Currently, the maximum annual contribution to such plans is $18,500 ($24,500 for workers age 50 and older). These contributions are tax-deferred, meaning the money isn’t taxed until it is withdrawn, presumably after retirement when workers may be in lower tax brackets.
Some House Republicans were thinking of reducing tax free or tax deductible contributions to as little as $2,400.
The difference between death and taxes is death doesn’t get worse every time Congress meets
From the government’s perspective, that would greatly increase the current taxes collected on wage income. From employees’ perspective, this would mean higher taxes and less money available for retirement savings.
Fortunately, the proposal never gained much traction.
However, this is a serious wake-up call to investors who are counting on current laws to remain unchanged. Congress can give us benefits, as it certainly did in 1974 with the advent of the IRA and again in the 1980s when 401(k) accounts were allowed.
The bad news is that Congress can always change the rules and the tax rates in the future, and this could negatively impact our expectations and plans.
I like this quote from Will Rogers: “The difference between death and taxes is death doesn’t get worse every time Congress meets.”
The good news is that we can resolve to be smarter with our retirement investments.
The two most important ways we can “be smarter” are to save more and to start saving sooner. No matter what happens to the laws or the economy, we’re better off if we have saved more money. And as most thoughtful investors know, time is a very powerful tool for generating long-term gains.
Despite the hundreds of breathlessly exciting articles and videos to the contrary, there is really no “secret” to saving more money. The way to do it is spend less and save more. I’ve never met anybody who regretted having saved more money. And I doubt that you will be the first.
I know of some creative and very effective ways to be smarter by starting earlier.
If you are reading this article, the probability is high that you’re past your early or mid 20s – the age bracket that will benefit the most from saving early. But if you’re in your 30s, 40s, 50s or beyond, the probability is very high that you have children, grandchildren, nephews or nieces who are young.
If you have the desire and ability to help a young person, you have an amazing opportunity to create a tax-free investment that can change someone’s life.
So here are four ideas.
Idea No. 1
The first idea is simple, and I’m still doing it for my two youngest daughters. Each one is in her early earning years and not making a ton of money. Each is maxing out her 401(k) contributions, as she should.
In addition, each daughter is eligible to contribute $5,500 a year into a Roth IRA, and the money and the earnings on it will never be taxed (unless the government retroactively changes the rules, which I think is unlikely).
My wife and I are funding these daughters’ annual Roth IRA contributions, which I’ve done for all my kids over the years. This does not take them off the hook; they still must max out their 401(k) contributions from their pay.
The result is that my kids have Roth retirement savings working for them while they are relatively young.
Simple math tells me this is a good investment. At 10% compound interest, every $1 invested at age 25 is worth about $45.26 at retirement age (presumably 65); by contrast, every $1 invested at age 40 is worth only $10.83.
Some parents will naturally be reluctant to make such a gift, knowing that their children could withdraw the money any time and spend it.
Knowing this possibility, I have made the following deal with my kids: If they cash out their IRAs before they are 59 ½ years old, while I’m alive that will be the last money they ever get from me.
This is more than fair, and they have agreed to it.
Idea No. 2
My second idea, which I’ve actually put into practice for each of my grandchildren, is much more audacious. I described it in detail in my book “Live it Up Without Outliving Your Money” in a chapter called “My 500-Year Plan.”
In a nutshell, here’s what I did. When my first grandson was very young, I gave him a $10,000 variable annuity in a form that prevents him from withdrawing any of the money until he is 65.
The money is invested in an all-value equity portfolio that will not be taxed until the distributions are made. When my grandson turns 65, he is to receive a lifetime “pension” from the annuity equal to 5% of the prior year’s ending value.
Otherwise he cannot withdraw the money. Upon his death, the remainder will be given to charities that he chooses.
This doesn’t take him off the hook for earning a living and saving for his own future. But it buys him a much more comfortable retirement than he would otherwise have.
This also allows for the possibility that he could retire on his own savings at age 55, knowing there will be another source of income when he’s 65.
(It also encourages him to do everything he can to live to be 65!)
This audacious plan flies in the face of conventional wisdom in several respects, and it’s not for everyone. But so far it has worked well.
Idea No. 3
My third idea is more suitable for a very young child, even a newborn. I call it turning $3,000 into $50 million.
The basic idea has been around forever: Invest $1 a day, starting on Day 1 of your life, and you’ll eventually have a nice nest egg.
Obviously a baby can’t start saving on Day 1. But a grandparent can, and $1 isn’t much. Neither is $365, which could be put away in the first week of a child’s life, then once again on every birthday.
Carried out through the 21st birthday, that plan would cost a grandparent a total of $8,030. Compounded at 10% (and ignoring taxes) on the child’s 21st birthday the account would be worth about $26,000
If Roth IRAs are still available and the $5,500 contribution limit still holds and the investment continues to grow at 10% that’s enough money to fund a Roth IRA for seven years or more.
As you can see in the article linked above, if this plan is carried forward for many years, the ultimate payouts could be astronomical.
It’s a great boost to a young person.
Idea No. 4
My fourth idea is also fairly simple. Loan a young person $5,500 to max out a Roth IRA, then make an additional $5,500 loan each year for another nine years.
Treat it as a real loan, with a written note, an interest rate (perhaps 3%), and a repayment plan.
If you begin this when the young person is right out of college at 23, by the time she’s 33 she will have invested $55,000 into the IRA.
She could probably afford to make interest-only payments for the first 10 years, then begin repaying the loan over a period of 10 to 20 years.
No matter what Congress does, your generosity will put her way ahead of the game.
For a start-of-the-year review of the market, check out my new podcast, “What you should know about 2017 returns.”
Richard Buck contributed to this article.