For the past 3 months, every tax newsletter, journal and other publication (I read a bunch of them in my never-ending struggle to stay current on the tax law) has had one or more articles on the virtues of Roth IRAs.
Here’s a quote from one of the more widely read newsletters: “Making a Roth IRA payin [for your child] is a great idea this year. You can contribute $3,000 a year if the child earns that much. . .a $1,000 increase over last year .” The article points out that a $3,000 contribution to a Roth IRA for a 15-year-old will mushroom to $88,000 per year, assuming 7 percent growth per year, when the person is 65. It will increase to $124,000 if the Roth owner lets it grow until he or she reaches age 70. Good stuff.
But a Roth IRA has some nasty rules that apply to all who want to play the Roth game: 1) No earnings, no contribution—contributions are limited to earned income or $3,000, whichever is less; 2) Earn too much and you are locked out of the game (a problem for many adults); 3) Subject to a few exceptions, withdrawals taken prior to the owner reaching 59 ½ are hit with a 10 percent penalty.
The good news is that although contributions to a Roth IRA are not deductible, withdrawals are tax-free (after age 59 ½).
However, there is another tax-advantaged way to prefund your child’s education that beats the pants off of a Roth IRA. It’s called a Tax-free Education/Retirement Plan (tax-free E/R plan). Here’s why a tax-free E/R plan is better than a Roth IRA. 1) Earnings don’t count, whether you have zero earnings or earn millions. 2) Withdrawals are always tax-free no matter when taken, and they can be used for any purpose (for a college education, to buy a home or for retirement).
You can start a tax-free E/R plan at any age; for a newborn, a 15-year-old or a 40-year-old. Annual contributions (actually premiums for a specially designed life insurance policy) to the Plan have no limit. The table on page 36 shows projected numbers for plans for different ages.
Two important points that are immediately apparent are the power of funds compounding in a tax-free environment and that youth will be served (by putting those education and retirement dollars away early).
Paid to Age
Number of Years
Total Paid In
Tax Free Withdrawals
College (4 years)
Home Down Payments (age 32)
Retirement ($150,000) Age 60 to 95
Total Lifetime Benefits
Death Benefits (age 95)
Total Benefit (age 95)