In 1716, Christopher Bullock wrote, “Tis impossible to be sure of any thing but death and taxes.” Two centuries later, researchers keep trying to disprove the first, while Washington DC seems intent on proving the second.
However, through the law of unintended consequences, Congress made it possible for you to make your kids millionaires without them having to pay a dime in taxes! What’s even better, it’ll cost you less than $20,000 per kid!
Like most parents, we do everything we can to help our kids succeed. This includes putting them through college, which these days is a six-figure expense per student in most decent schools.
Still, this is a good investment based on information from the Social Security Administration that says a college degree increases lifetime earnings by more than $630,000, and a graduate degree may be worth over $1,100,000.
While a college degree can generate a lifetime return of 500% or more, here’s another approach that significantly tops that lifetime return on your investment. In fact, with the right strategy, you can set your child up to become a millionaire—tax-free—before they even turn 60, and for less out-of-pocket cost than a year’s tuition at many universities.
This isn’t just about stashing away cash or investing in the usual college savings plans. By leveraging a little-known but perfectly legal IRS loophole, you can give your child a massive head start on building wealth—one that could easily eclipse the financial benefits of even the most prestigious diploma. And the best part? The math works out so that you don’t need to be a financial wizard or a high earner to make it happen.
Let’s break down exactly how this can work for your family.
What You Need to Help Your Child Become A Millionaire
To make this work, you need just three things.
- A business willing to hire your teen(s), paying enough to make at least $5500 a year working part-time
- Your teens’ willingness to work while in school and their agreement to invest $5500 of earnings each year without touching it until retirement (this is a tough one, which is why you need the next and final piece)
- Since most teens aren’t big on delayed gratification, you need $2750 a year for seven years, to gift your teen $0.50 of spending money for each dollar she invests
How Does It Work?
When Congress passed the Taxpayer Relief Act of 1997, they established the [Roth IRA](http://www.rothira.com/roth-ira-rules). In this individual retirement arrangement, you contribute after-tax money, but no taxes are ever due on withdrawals in retirement. The critical part is that contributions must come from income earned on work.
Now before you object, “you said this is without paying taxes and now you say contributions have to be after tax!” — that’s why I said you need a teen, who will likely not earn enough to owe income tax and who has a very long time until retirement.
Here’s how the strategy comes together:
- From age 16 until graduating from college at age 22, your teen works and earns at least $5500 each year
- You help your teen open a Roth IRA (e.g., with a low-cost, no-load S&P 500 index fund or a good target-date retirement mutual fund)
- Each payday, your teen invests her entire paycheck, until the year’s total hits the Roth IRA contribution limit (currently $6000 in 2022)
- Unless your teen is happy delaying spending any of those earnings for a few decades (yeah, right!), you offer a match of $0.50 spending cash for each dollar sent to the IRA
- If needed, you help your teen file annual tax returns that will most likely show no tax owed. This step is usually simple, since most teens won’t earn enough to trigger federal income tax liability—but it’s important to file anyway to document that their Roth IRA contributions came from earned income. This paperwork helps keep everything IRS-compliant, and in rare cases where your teen does owe a tiny amount (maybe from a brief stint at a high-paying summer job), you can help them navigate those waters without stress.
A Few Practical Notes:
- The Roth IRA is uniquely powerful for teens because their income is usually low enough that, even after payroll taxes, their federal income tax bill is typically zero. This means every dollar contributed is essentially “tax-free” in and out.
- Most custodial Roth IRAs allow you, as the parent or guardian, to assist with opening and managing the account until your teen reaches adulthood.
- For investment choices, consider a broad-market index fund, such as an S&P 500 fund, or a reputable target-date retirement fund—both offer low fees and automatic diversification.
- If your teen’s summer or part-time earnings fall short one year, you can still contribute up to the total amount earned from work, up to the annual Roth IRA limit.
With a little encouragement (and some matching funds for motivation), you’re setting up your teen for a lifetime of tax-free growth—and possibly millionaire status—before they even get their first “real” job.
What’s the Result?
I created the following (very simplified) table with an assumed average annual return a tiny bit over 7% (US stock market annual returns have averaged about 10% since before the Great Depression), and a retirement age of 67. As you can see, with $5500 annual contributions from age 16 to 22, your teen would have over $1 million at retirement.
Illustration of contributions and their value at retirement age of 67, assuming an annual return just over 7%.
That’s it! Your teen contributes $38,500. You partially match that at a total cost of $19,250. Your teen retires as a millionaire even with no other retirement investment; and since it’s a Roth, withdrawals in retirement are tax-free so this is worth much more than the same million dollars in a tax-deferred account.
What’s the Catch?
There are of course a couple of caveats (aren’t there always?), but they’re not too bad. First, stock market returns aren’t guaranteed; but over a 45-to-52-year period, they should be reasonably safe.
Second, inflation will nibble at the dollar, so a million bucks will be worth a lot less 52 years from now than they’re worth today. Still, it’ll be a whole lot more than most people have when they (want to) retire these days.
That’s not to say this approach is completely bulletproof. The market can be a roller coaster, and while history suggests the long-term ride trends upward, there will definitely be bumps along the way—think dot-com bubble, Great Recession, or the occasional pandemic-induced chaos. And yes, by the time your teen retires, what feels like a small fortune now may not buy quite as many avocado toasts or electric cars as you’d hope. But even after accounting for inflation and the occasional market downturn, ending up with a tax-free seven-figure nest egg is a pretty enviable outcome compared to the average retiree’s situation.
So, while it’s not a magic trick guaranteeing instant wealth, it’s still a serious leg up on the future—and a far more comfortable retirement than most folks can expect.
Not a bad return for less than a single year’s cost of attendance at a good state university, wouldn’t you say?
Disclaimer: This article is intended for informational purposes only, and should not be considered financial advice. Before making major financial decisions, please speak with us or another qualified professional for guidance. The original version of this article first appeared on Wealthtender written by Opher Ganel.