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How To Turn $5,000 A Year Into a $33 Million Legacy

$5000 by AMagillWith a headline like that I bet you’re thinking this is one of those wild & crazy get rich schemes… which it may be, but it’s mostly a demonstration of the great benefits of three factors that can work in your favor in building a legacy:

What follows is an example of how you can make those three factors work together to create this $33 million legacy.

How It All Started…

Once upon a time, there was this guy named Joe.  He was 20 years old, working part-time making decent money, finishing up college, just generally living large (by a 20-year-old’s definition).  On the advice of his father (yes, some 20-year-olds listen to their fathers!), he opened up a Roth IRA, funding it with $5,000.  The account was invested in a fixed 5% yield instrument of some sort (not important what the investment is, just assume a 5% annual yield).

Using the Roth IRA is advantageous to Joe because his tax rate is very low at this stage of his life – presumably tax rates will be increasing for him in the future.  Any growth on this account is tax-deferred and most likely tax-free, as long as any future distributions are for qualified purposes.

Each year thereafter, Joe contributes an additional $5,000 to the Roth account.  After he completes college, he starts working at an entry-level job.  Not long after, he marries his high school sweetheart Jane, and they settle into their life.  As life goes, they soon have children in their household, and even though money is tight, Joe continues to contribute the $5,000 each year into his Roth IRA.  This goes on for a while.

And then… 20 years pass

At age 40, Joe launches his own business.  During this time in his life, tax deductibility becomes more important to him since he’s making a lot more money and is in a higher tax bracket – and so he stops contributing to the Roth IRA.

All this time, his investments in the Roth account have been steadily growing at that fixed 5% rate – and the balance is now up to $165,329 – on 20 years’ worth of $5,000 investments, for a total of $100,000 contributed.  Pretty nice, right?

Joe just sets the Roth account aside at this point, forgetting about it altogether for quite a while (other than those pesky quarterly statements).  Not much happens here for a long, long time, other than compounding interest, time passing, and continued tax deferral.

… and another 50 years pass

Joe is now age 90.  His business has flourished through the years, and now his children are reaping the benefits of having worked there, and now retiring.  His grandchildren have taken over the business, and he and Jane are enjoying their great-grandchildren.  A couple of years later, little Jolene is born, and this great-granddaughter quickly becomes the apple of Joe’s eye.

It is along this time that Joe remembers that long lost Roth IRA account.  To this point it has grown to over $2 million – from that original series of $5,000 contributions that amounted to a total of $100,000.  Pretty amazing what can happen with compounding interest, right?  Now Joe has plenty of other assets that he intends to bequeath to his children: the business, other retirement and investment accounts, etc..  This Roth IRA though, he’s decided to really make a legacy out of it, and decides to name his great-granddaughter Jolene, a newborn, the primary beneficiary of the account.

… and then, a couple of years later…

At age 95, with his family surrounding him, our friend Joe passes away.

little girl by ganessasLittle Jolene is now two years old, and as primary beneficiary of the Roth IRA (now worth over $2.4 million) must begin taking Required Minimum Distributions from the account, based on her age.  Her Table I factor is 80.6, and so her first distribution is for just over $30,000.  Her parents file the necessary paperwork and then they put this money away for Jolene’s college education fund.

And so on it goes, the account continuing to compound at 5% each year, Jolene receiving her RMD each year, and her parents putting that money away for college.

Fast forward some more…

Little Jolene has graduated from high school, and intends to go off to college.  Over the past 16 years since her beloved great-grandpa Joe passed away, she has received a total of over $650,000 in distributions from the Roth IRA that he left for her.  This has made for a nice start on her college costs.  (We won’t get into it now, but if we projected college costs out this far into the future, a year of college would be more than $6 million at the 7% rate of increases we’ve seen recently.)

So Jolene finishes college, and she continues to receive the RMD payments from the gift from great-grandpa Joe throughout her life.  She lives a long, full life, with a loving family and great success.  At age 82, according to the original Table I factor, she has depleted the inherited Roth IRA.  The total of all of the RMD distributions she received over those 80 years amounts to $33,069,557.  Not too shabby for Joe’s $5,000-a-year commitment over 20 years.

Note:  other than acknowledging the factors, income taxes, inflation, and transfer taxes have not been factored into this example.  This example is only intended to demonstrate the value of long-term investing, compounding of interest, and tax-deferral benefits of Roth IRAs, plus the stretch provisions.  This example is not intended to represent real life situations, although it is certainly feasible.  Bear in mind that this entire activity took place over the span of approximately 155 years.

Photo #1 by AMagill
Photo #2 by ganessas

One Comment

  1. […] that can be realized over time by naming a very young person as the beneficiary of your IRA (see “How To Turn $5,000 A Year Into a $33 Million Legacy” for details).  This makes for a very elegant, clean tax-planning exercise; but in reality, a […]

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