By Paul A. Merriman
With Kevin’s encouragement, Madison has entrusted the management of her IRA to a fiduciary adviser who understands the whole arrangement.
It’s impossible to accurately predict the financial results of this plan.
But we can get a rough idea from a table developed by Daryl Bahls, director of analytics at the Merriman Financial Education Foundation. That table assumes $6,000 is invested in a Roth IRA annually for five years starting at age 21, and that the money achieves a compound annual growth rate of 12%.
That long-term rate is not unreasonable for an all-equity portfolio. Since 1928, an index of U.S. small-cap value stocks grew, on average, at 13.4% annually.
Because her IRA got its first infusion of cash at age 18, she will have a three-year head start. Therefore I expect her results to be better than what I’m about to describe.
Our table shows that five annual investments of $6,000 starting at age 21 would grow to be worth about $3.5 million at age 65. Over 30 years of retirement, the IRA owner could withdraw a total of $15 million, with each annual withdrawal calculated at 5% of the prior year’s account balance.
And after 30 years, at age 95, the account would still be worth about $22 million.
Calculated that way, the initial $30,000 eventually generates $37 million.
However, those numbers are deceptive because they don’t take inflation into account.
When you assume 3% annual inflation through this whole long period, the projected results are much lower—but still impressive.
The inflation-adjusted value of the account at age 65 becomes about $960,000, producing a first-year retirement payout of $48,000. That’s not all that Madison would need to retire today, but it’s a terrific start. (And just that figure alone, in real dollars, is much more than the entire initial $30,000 that Kevin invested.)
Read: 5 smart money moves for your first 5 years of retirement
Thirty years of inflation-adjusted withdrawals would add up to $2.4 million, and the age-95 account value would be about $2.5 million. So in this case, using constant-value dollars, $30,000 would generate nearly $5 million.
A vital part of the arrangement is her education. Kevin told me he has given Madison copies of two books I wrote with Richard Buck: Financial Fitness Forever and We’re Talking Millions! 12 Simple Ways To Supercharge Your Retirement .
Kevin understands he won’t be around to see the final outcome of this joint plan with his niece. He knows he has to trust her to not raid the money when (inevitably) a need arises for some or all of that money.
For a plan like this to work, both parties have to follow through on their commitments. Kevin has no worries about Madison, who is an honor student and driven to attain her goals.
He made a similar arrangement a few years ago with another young relative, fully funding five years of maximum IRA contributions for her.
When she got into her mid-20s, this young woman had some health issues, then was hooked on drugs and—by her account—barely escaped with her life. Yet, through all that, she left her IRA intact, regarding her agreement with Kevin as sacred. That seems like a very powerful ingredient in this recipe for long-term investment success.
Kevin said he’s considering putting the agreement with Madison in writing and asking her to sign it, even though it’s not legally binding, as a pledge to him.
Most parents, grandparents, aunts and uncles would be likely to struggle with the cost of giving a young person $6,000 a year for five years—especially when college costs are looming.
But a similar result is possible with contributions as low as $25 a month. For more on that, check out my latest podcast .
Richard Buck contributed to this article .
