How To Make SECURE 2.0 For The Children
How can Congress and the Administration get working teenagers to save by opening a Child IRA? This is a question that no one is asking. It is, however, the best question that everyone should be asking.
You’ve probably seen many reports about the lack of retirement savings. Currently, there’s a debate regarding whether this is due to not having access to a corporate retirement plan or simply because workers have chosen not to save. Whichever is the case, it’s clear that starting the savings habit early will go a long way to solving this problem.
Every working person can save for retirement through an IRA. You don’t need your company to set one up for you. You can do it all by yourself.
What if, instead of focusing only on adult retirement savings, regulators and legislators made a determined effort to encourage the establishment of Child IRAs?
You might think that this is only a nickel and dime solution to a dollar-sized problem. But those nickels and dimes add up exponentially over time.
A newborn baby needs only to save $1,000 a year until age 19 to have more than $2 million at retirement. Even teenagers can take advantage of this same compounding. By saving the IRA contribution maximum ($6,000) every year from age 13 through high school graduation (age 18), teens can retire with $2½ million.
Actually, these numbers are quite conservative. First, they expect today’s children will retire at age 70. Second, the calculations assume these Child IRAs are invested poorly. Instead of earning the historic average of between 10% and 11% per year, they use only an 8% annual return.
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If these Child IRAs merely grow at the historic average, those assets will grow to more than $10 million by retirement. And this does not include any retirement savings during adult years. Will this generation even need Social Security?
If Congress can figure out a way to add a streamlined Child IRA provision to the SECURE 2.0 legislation they’re currently talking about, they may actually solve a bigger long-term problem. How, exactly, then can they encourage working teens (and younger children) to save for retirement?
Since Washington seems interested in solving problems in general, many are offering ideas on the specific issue of Child IRAs. Some solutions are elegantly simple. Others contain a lot of moving parts.
Perhaps the easiest way to encourage saving in Child IRAs is to allow unrestricted contributions in a fashion similar to how 529 plans are treated today.
“Currently, working minors can contribute up to 100% of their annual earnings to a Child IRA,” says Jay Abolofia, Founder of Lyon Financial Planning in Waltham, Massachusetts. “One way to encourage greater use of such IRAs might be to remove the earned income contribution limits. For example, allowing teenagers or their custodians to contribute up to the maximum amount each year, independent of whether they have any earnings or not.”
Another possibility to quickly build savings is to mimic the matching provision similar to what you see in 401(k) plans.
“One way our country can get working teenagers to save by opening a Child IRA would be to allow parents to match the contributions made by their teens,” says Steve Pilloff, Associate Professor at the School of Business, Finance Area for George Mason University in Fairfax, Virginia. “This would basically create a tradeoff for the teens between spending $1 today and saving $2 today.”
What if this match produces too great a burden on parents? “Another option is for the government or employers to provide a matching contribution to minors who contribute to their IRA,” says Abolofia. “This would provide a direct financial incentive for working teenagers to contribute.”
Of course, matching doesn’t have to be dollar for dollar or even direct contributions. The government is trying to tackle any number of issues, and there’s no reason to believe it can’t create synergistic solutions. Granted, these may be complex and narrow accessibility because fewer and fewer would be eligible.
“We can start by providing a credit against federal student loan payments,” says Aaron Shapiro, Founder and CEO of Carver Edison in New York City. “An example of this would be for every $100 saved in a Child IRA, the government can provide $15 off of federal student loan payments. This would provide big incentives for our government, as more personal savings provides a cushion against government financial support.”
In a similar fashion, not all legislative or regulatory action needs to have a direct impact. In fact, you might consider it a two-pronged attack: one direct and one indirect. The direct strategy involves specific rules regarding Child IRAs as described above. The indirect strategy involves laying the psychological groundwork to build an understanding of and expectation for the benefits of creating a Child IRA.
Where is the best place for this behavioral approach? “I believe if the government provided better quality financial education in K-12 then there would be a greater impact from a Child IRA,” says Josh Bennett, Founder of Vincere Wealth Management in San Francisco.
“We can encourage working teens to open Child IRAs by educating them, along with their parents, with examples of the great impact IRAs can have on their future and putting the child in the starring role so they envision their future,” says Teresa Koch, AVP of Marketing at Orange County’s Credit Union.in Santa Ana, California.
Again, this particular idea also addresses the related problem concerning financial literacy.
“Education is key,” says Jennifer Garcia, Managing Director for the Garcia Private Wealth Group of Wells Fargo Advisors in Encino, California. “Our country needs to focus on financial literacy in high school. By requiring students to take a class in finance, we can educate them on the basics of savings as well as the different ways to save. This type, of course, should teach everything from budgeting to saving. Demonstrating the difference between a savings account vs an investment account will build a foundation to understanding, at a young age, the benefits of saving. This conversation should focus on the advantages of investment accounts including Child IRAs so that our youth is prepared and knowledgeable about what options they have to save money when they are hired for their first job and enter the workforce.”
The challenge here is to retain the student’s attention. This becomes more difficult as the child progresses through middle school.
“Many teens might live in the moment, but financial literacy is crucial for long-term financial success,” says Nicole Watson, SVP/Territory Delivery Director at UMB Bank in St. Louis. “It’s important to learn how to save money, and children and teens benefit from gaining first-hand experience and learn as additional responsibilities are given to them. One way to let your child show their responsibility is by setting up their own youth savings account or investment account.”
Here’s where educators need to get creative in order to teach financial literacy effectively. Perhaps new guidelines from the Education Department can help.
“Make it interesting and fun for them!” says Claudia Gonzalez, Chief of Advisors at Kovar Wealth Management in Lufkin, Texas. “Start by figuring out what teenagers are into games, electronics, clothes, etc. Have them research those companies and show them how they can invest in them. The teenager will be so proud to know they own something they love!”
Games have a way of speeding up time; therefore, they can more quickly show the impact of long-term strategies. This is particularly useful when it comes to retirement. For many young adults, retirement is so far away they feel they can avoid it. They don’t see why it’s important to start saving early. If this is how some adults think, imagine what kids think about it.
“We have to explain the why in a more compelling way,” says Tremaine Wills, Financial Planner at Mind Over Money in Newport News, Virginia. “You must get teens to care about the reason they aren’t spending all the money. Saving for retirement isn’t a good enough reason. That seems so far away. But when we break it down and explain that putting $6,000 into this account every year will make you a millionaire one day, that’s a bit more tangible.”
Speaking of adults, don’t forget to let parents in on this. While this article has focused on what the government can do, parents are in the best position to help encourage their children to start, save in and grow Child IRAs. Strategies need to be employed to bring parents in the loop.
“Education will be key,” says Matt Schulz, Chief Credit Analyst for LendingTree TREE in Austin, Texas. “I’d bet that most parents have no idea that they could sign their kid up for a Child IRA. If their parents don’t know and their schools aren’t teaching much about personal finance at all, the kid will never know the Child IRA is an option. A concerted effort on the part of the government, business and schools could help change that.”
It doesn’t take a single instrument to sow the seeds to long-term financial comfort, it requires an entire orchestra of instruments working in harmony towards achieving a common goal. Perhaps SECURE 2.0 can direct this symphony.
After all, it’s for the children.