The following column from Phoebe Venable, CapWealth President & COO, appeared in The Tennessean on January 29, 2016.
The market hasn’t been pretty so far this year. And while I don’t want to gloss over the agony, I’m going to, sort of, by saying: Don’t worry.
The fact of the matter is that, for the long-term investor, a degree of nonchalance isn’t only admirable, but effective. It means you’re focused years down the road, which history teaches will in probability lead to a market at a higher watermark than today, albeit with plenty of zigs, zags and nosedives along the way. It means you’re strategic, diversified and don’t rely on emotion — a sure growth-killer — when investing.
If you’re still worrying, try this. Instead of dwelling on your portfolio’s dollar amount today, force yourself into long-term thinking by opening a 529 plan or a Roth IRA for your child or grandchild.
What is a 529 plan?
A 529 plan is a savings plan operated by a state or educational institution to help families grow their money for future college costs. These plans can be used for any college regardless of where you, the plan or the college are located. The benefit? An outstanding tax break! Although contributions aren’t tax-deductible, the earnings grow federal tax-free and won’t be taxed when taken out for college. Moreover, most states offer residents a full or partial tax deduction or credit for their 529 plan contributions. There are penalties for non-qualified withdrawals.
There are two varieties of 529 plans. The first are savings plans that work like a 401(k) or IRA, offering investment options such as indexes or age-based portfolios that automatically become more conservative over time. There are also prepaid plans that let you prepay in-state public tuition, often allowing you to convert its use to private and out-of-state colleges. Beyond these two broad categories, the details of fees, investment options, contribution matching and more all differ across plans, so compare them.
The TNStars 529 plan, administered by the Tennessee Treasury Department, has a solid reputation. There are 14 investment options to choose from, fees are capped at a relatively low 0.35 percent and investments are exempt from the state’s Hall income tax. Quite impressively, SavingForCollege.com has ranked its investment performance one of the top five directly sold plans in the U.S. for five consecutive quarters. Visit TNStars.com for more information.
Roth IRAs are for everyone
Many people don’t realize there’s no minimum age for starting a Roth IRA, unfortunately leaving this powerful wealth-making tool underutilized. As with 529 plans, the money going into a Roth IRA gets no tax deduction but coming out enjoys full tax exemption. The money can be invested in stocks, bonds, Treasuries, mutual funds, whatever.
It’s such an amazing deal that the government puts limits on it: The total yearly contribution (as of 2016) is capped at $5,500, the contributed amount must come from a real job trackable by the IRS, there’s an annual income limit on participation and there are tax and penalty fee consequences for withdrawing before age 59 1/2.
Some of these limits can make deciding between a Roth and a traditional, tax-deductible, tax-deferred IRA tough for middle-aged workers. But for nearly all kids and many teens and college students, the Roth is a no-brainer because they simply don’t make enough to pay taxes or come close to the income threshold.
The difference 10 years can make
Let’s say your 15-year-old makes $2,500 a year mowing lawns or babysitting. As a parent, you insist they save all, part or none of it. With a Roth IRA, he or she could put their saved portion in it and as a parent or grandparent — if you had the means and the desire to do so — you could match or make up the difference up to $2,500, or up to $5,500 if the teen earns that much.
Why in the world would a 15-year-old start investing? Besides the invaluable lessons in priority setting, money management and delayed gratification, here’s why. That yearly $2,500 investment, assuming an average 7 percent annual return, will grow to more than $1.16 million by the time your child is 65. If your 15-year-old waits until age 25 to start, that number decreases by more than half to $570,000. That’s the astounding difference 10 years makes in compounding interest. Either way, it’s an enormous boon in a future possibly devoid of pensions and Social Security. A final bonus: There’s no early-withdrawal penalty for college tuition or the purchase of a first home.
For additional advice planning your child’s educational and financial future, talk to your financial adviser.
Phoebe Venable, chartered financial analyst, is president and COO of CapWealth, LLC. Her column on women, families and building wealth appears every other Saturday in The Tennessean. To read Phoebe’s previous column, click here.