Real Estate Tax Pros

Helping Those Working In and On Real Estate

Two Wealth-Building Tax-Cut Strategies for Kids and Grandkids

One of the easiest ways to create generational wealth and avoid taxation is to invest in a child’s education and future - the most common method is saving for college or vocational school. Historically, this makes sense. Traditionally, education was one’s surest bet to achieve generational wealth and prosperity. Unfortunately, however, this correlation is less evident than it used to be. The cost of a university education has skyrocketed in recent decades, making prosperity an increasingly relative term. For many degrees, the return on investment no longer justifies the cost.

We’ll discuss an alternative, generational, tax-cutting prosperity builder momentarily. But first, let’s review our highly-marketed go-to method - the Section 529 Plan.

Strategy 1 - The 529 Plan: Most are familiar with Section 529 educational plans. They allow a parent or grandparent to save for a family member’s educational costs, including vocational school. As a general rule, states allow a tax deduction for plan contributions. Plus, earnings grow tax-free, and 529 distributions are tax-free when used for education. Also, new legislation allows a limited rollover of unused 529 funds into a beneficiary’s ROTH IRA starting in 2024 (a sweet deal, which we will discuss in a later newsletter).

Unfortunately, as I mentioned earlier, the cost of college has made the ROI (return on investment) on many degrees questionable (at best). The traditional belief that college-learn-ed-ness is financially superior to other vocations has become a myth in many instances.

As someone with first-hand knowledge of income earned in many professions, I can confidently share the following: The earnings of many individuals in hands-on vocations such as plumbing, electrician, HVAC, computer security, or real estate (especially those who have initiative and some business know-how) regularly surpass that of college graduates.

The child/grandchild retirement strategy described below may prove far superior to education in terms of both earnings and ultimate tax savings. But there is no rule against saving via the 529 plan and funding a descendant’s ROTH IRA. The two strategies may overlap because qualified and unused portions of Section 529 balances now qualify for ROTH Rollovers!

Strategy 2 - HELP FUND THEIR ROTH EARLY. Albert Einstein (so the rumor goes) said that compound interest is the most incredible power in the universe. Whether he said it or not, it’s a statement of fact - at least regarding finances. And - the best part - the resulting prosperity requires no exerted effort, just time and the discipline to NOT touch the money!

The compounding principle is pretty simple. When we invest money with a bank, it (hopefully) earns interest on the savings. Similarly, stocks and mutual funds often generate dividends while (hopefully) increasing in value. Reinvesting the interest or dividends earned into the same investment will produce even greater earnings in the future. The earning-reinvestment process is called compounding.

Here’s a basic example. If we invest $100 and it earns 5% per year, at the end of year one, we’ll receive $5. Reinvest the $5, and we have $105 making 5%. At the end of year two, we earn $5.25. Reinvest the $5.25, and we have $110.25 earning 5%. The earnings may not seem like much until the time factor gets added. After five years, we have $127.63. After fifteen, our $100 investment has doubled to $201.14. In thirty years, it’s worth $371.29. And in forty years, it’s grown over 500% to $537.82!

Not impressed? Consider this. Returns on stocks and mutual fund investments vary widely year-to-year, but they’re far higher than 5% over time. In fact, from 2012 to 2021, the S&P 500 (representing the market as a whole) earned an average return of 14.8% per year, 12.4% adjusted for inflation. From 1992 to 2021 (30 years), it averaged 9.9%, 7.3% inflation-adjusted.

Grandparent Super Stars: Imagine your parents or grandparents understood the power of compound interest and set aside a little money each year from the day you were born. And, on the day you turned twenty, this nest egg totaled $25,000. And you know what else? They were also young once and decided not to tell you (at least until you were thirty—no, forty - Forty’s safer) to avoid the likelihood of you blowing the money on something cool like a car, a vacation, or someone’s wedding.

So, instead, they invested the money in a ROTH IRA in your name, and the ROTH’s annual earnings averaged 10%. How much would this $25,000 be worth when you turned fifty?

What about age 60?

Retirement and Generational Wealth Secured: Most of us do not think seriously about retirement until we’re in our mid-thirties, and that’s early for many. We’re busy working, having fun, and raising children, so retirement is not a front-burner priority. Then, as the aches and pains of approaching mid-life point us toward our eventual retirement, we panic and scramble to save what we can.

And what do we lose? A large amount of compounding and potential earnings! If you’re 35 and start saving $5,000 annually every year until you reach 60, you’ll save $125,000. But what will it be worth? Earning the same 10% annually as your grandparent’s single ROTH deposit, you’ll have about $492,000 at age sixty. That’s less than half of what a single investment of $25,000 at age 20 would be worth!

So what’s the plan? Here are the steps:

  1. Start saving money for the child each month as early as you can. As little as $75 per month for 15 years will result in over $20,000 if it averages 7% earnings.

  2. As soon as the child has earned income (required to fund a ROTH) from a part-time job, open and start transferring money to the ROTH up to the annual limit.

  3. Don’t tell them about the ROTH. If you have to, downplay it so they forget it’s there.

Section 529 Interplay: We will revisit this topic as a stand-alone newsletter article later. The new 529-ROTH rollover rules may make it even easier to achieve current tax-advantaged savings to fund the ROTH while protecting the funds from the beneficiary’s youthful-priority looting.