Monday, December 17, 2007

Save For Your Kids Retirement via a Variable Annuity

I read an interesting personal finance article by Jonathan Clements in the Wall Street Journal today. He talked about a bunch of ways to teach your kids about money. Now, I'm not going to be your typical blog where I list the ways and a brief summary of each one, then put my own spin on it. Bloggers who do things like this are lazy, unoriginal hacks who are basically just stealing their work from other people.

I am, however, going to key in on one particular idea I hadn't considered before. When I read about it, I thought it was the first time I'd ever read about it, but it turns out after consulting a June 2005 Clements article on teaching kids how to save I realized came across the idea a few years ago. (As an added bonus, if you read Clements' 2005 article along with the one above, you get a better picture of the actual dollar amounts he saved for his kids, offered for allowances etc...)

The idea is investing in a variable annuity to fund your child's retirement.

You heard me right, retirement, not school, not college, not graduate school, not weddings... RETIREMENT. Saving for your kid's retirement.

For most people, this is very low on the list of priorities. However, for people who are more financially comfortable, just think about how long that compounding period is... about 60 years if you put money in when the child is born. If you invest $2,000 and earn market returns of about 9% for 60 years, your child will end up with about $352,000 for retirement. Add contributions of just $100 a year to that initial $2,000 investment and your child will end up with $547,000. Add contributions of $335 a year and the initial investment will turn into about a million dollars in 60 years.

The reason why he opted for a variable annuity rather than a Roth IRA is that his kids would need to have income in order for him to contribute to a Roth IRA and being an infant at the time, the kid probably didn't have any income. The variable annuity allows for tax-deferred growth without an income requirement. (Incidentally when his daughter got her first job waiting tables or something, he opened a Roth for her.)

Sometimes when I look at my own retirement projections I wish I had another 30 years to tack on to let the really good compounding take effect at the end. In effect, if you open an account for your kids, this is what you're doing.

Does anyone have any thoughts on this? I think it might be something interesting to look at if I'm looking for alternatives for my child's birthday money etc... Of course I think I'm going to have my hands full with saving to help them through college first, but this is always something to think about. It's also pretty clever.


think like the rich said...

i admit i came here today to find a book recommendation for a book about asset allocation, but as i read this post this actually sound like an interesting idea. i had this issue recently when my mother wanted to gift some $ to my nephew, and we had to decide how to invest it. i complain often about variable annuities, but i'll admit this is not a bad option. we ended up spreading the cash among 3 index funds at vanguard, and left it in my mothers name with my nephew as sole beneficiary.

Jonathan said...

I've thought about this before, but how's this for an idea:

My kid's inheritance = how I help them save for retirement

Whatever I don't need, they can have =)

Amanda said...

I love how I've become your regular punching bag, MoneyMan. Cheers.

Miserly Bastard said...

My wife and I have been following this strategy now for two years. Our plan is to fund $10k a year for as many years as we are earning a large income. I blogged about this here:

One of the things that I think you need to consider, which Clements' article neglected, is the psychological aspects of the investment, i.e., maintaining incentives for work for your child.

MoneyMan said...

Jonathan, I think your idea is probably what most people end up doing and will work out. However, it looks like VAs are a more tax efficient way to go.

Amanda, I don't consider you a punching bag, I like your site and read it a lot. You're on my recommended blogs list.

Miserly Bastard (great name), interesting post, thanks for passing it along.

I like Warren Buffett's quote on that he plans to leave his kids "enough so that they can do anything, but not enough so that they can do nothing." I definitely agree that your kids need incentive to work, or you'll end up with Paris Hilton offspring. However, I'd say the vast majority of people reading my site won't have to worry about this issue (and don't think I will have to either) because a) only a very small percentage of the population will ever be rich enough to leave an inheritance that their kids can live off and b) that small percentage isn't very likely to be reading my blog. :)