When They’re 64
WHEN MY TWO CHILDREN were ages nine and five, I opened Vanguard Group variable annuities for them. No, variable annuities aren’t my favorite investment. Far from it. Indeed, I don’t think they’re anybody’s favorite investment vehicle, unless you happen to be an insurance agent angling for a big commission.
Still, tax-deferred annuities differ from other retirement accounts in one crucial way: You don’t need earned income to fund the account. That means it’s possible to open a tax-deferred annuity for a toddler, thereby setting the kid up for decades of investment compounding.
Children may not have a whole lot of money, unless their parents pitch in, but they have something even more valuable, which is time. The accounts I opened for Hannah and Henry, now both in their 30s, are today comfortably into six figures. Hannah was sufficiently impressed by her account’s growth that she asked me to open variable annuities for her two kids—my grandchildren—who are ages four and one.
Since I set up the accounts for Hannah and Henry, Vanguard has unloaded its variable annuity business to Transamerica. Still, at 0.27% of assets a year, the variable annuity’s contract charge remains reasonable, the funds offered within the variable annuity are low-cost Vanguard offerings, and there’s no commission to buy or sell. But I can’t shake the worry that all this could change now that Transamerica is the administrator.
That’s why, for my two grandkids, I opted instead for Fidelity Investments’ variable annuity. The Fidelity Personal Retirement Annuity’s contract charge is 0.25% a year and, if you pick carefully, the fund expenses can also be fairly low. I settled on a 50-50 split between the total U.S. stock market index fund, which costs 0.11% a year, and the international index fund, which charges 0.16%. The accounts are set up as custodial accounts, with my daughter as the custodian. Custodial accounts count heavily against families in the financial-aid formulas, but I doubt my two grandchildren will be eligible for aid, given their parents’ income.
Is it really worth buying a variable annuity—even a low-cost one—to give a child an early start on a lifetime of investing? Suppose my grandchildren own their variable annuities for 60 years, which is likely because the 10% penalty on withdrawals before age 59½ creates a healthy incentive to leave the money untouched. Let's also suppose their accounts earn an after-inflation 6.6% a year. This assumes the stock market delivers 7% a year, but investment costs snag 0.4 percentage point of that annual return.
At 6.6% a year, the $10,000 that I invested for each grandkid will be worth an after-inflation $463,000 after 60 years. What if I hadn’t bought the variable annuities, and instead they started on retirement saving in their early 20s? At that juncture, they’d be looking at perhaps 40 years of compounding. At 6.6% a year, $10,000 would grow to some $129,000, or 72% less than the $463,000 they’d have with the earlier start.
You could quibble with these numbers, especially the return assumption. Still, it’s clear that snagging an extra 20 years of compounding makes a huge difference.
When I was investing for Hannah and Henry, I didn’t just open variable annuities for them. I also set up taxable accounts where I invested money for a future house down payment. Later, when they had some earned income, I opened Roth IRAs on their behalf.
I would, of course, love to open Roth IRAs for my grandkids. Think about it: decades of stock-market compounding, all of it tax-free. It's a gift I'd love to see given to every young person—and perhaps the savings initiative launched last week will help to make that happen.
Unfortunately, at ages four and one, my grandchildren don’t have the earned income needed to qualify for a Roth. When they do, I hope their parents will remember this article—and open Roth IRAs on their behalf.
Jonathan Clements is the founder and editor of HumbleDollar. Follow him on X @ClementsMoney and on Facebook, and check out his earlier posts.
Still, tax-deferred annuities differ from other retirement accounts in one crucial way: You don’t need earned income to fund the account. That means it’s possible to open a tax-deferred annuity for a toddler, thereby setting the kid up for decades of investment compounding.
Children may not have a whole lot of money, unless their parents pitch in, but they have something even more valuable, which is time. The accounts I opened for Hannah and Henry, now both in their 30s, are today comfortably into six figures. Hannah was sufficiently impressed by her account’s growth that she asked me to open variable annuities for her two kids—my grandchildren—who are ages four and one.
Since I set up the accounts for Hannah and Henry, Vanguard has unloaded its variable annuity business to Transamerica. Still, at 0.27% of assets a year, the variable annuity’s contract charge remains reasonable, the funds offered within the variable annuity are low-cost Vanguard offerings, and there’s no commission to buy or sell. But I can’t shake the worry that all this could change now that Transamerica is the administrator.
That’s why, for my two grandkids, I opted instead for Fidelity Investments’ variable annuity. The Fidelity Personal Retirement Annuity’s contract charge is 0.25% a year and, if you pick carefully, the fund expenses can also be fairly low. I settled on a 50-50 split between the total U.S. stock market index fund, which costs 0.11% a year, and the international index fund, which charges 0.16%. The accounts are set up as custodial accounts, with my daughter as the custodian. Custodial accounts count heavily against families in the financial-aid formulas, but I doubt my two grandchildren will be eligible for aid, given their parents’ income.
Is it really worth buying a variable annuity—even a low-cost one—to give a child an early start on a lifetime of investing? Suppose my grandchildren own their variable annuities for 60 years, which is likely because the 10% penalty on withdrawals before age 59½ creates a healthy incentive to leave the money untouched. Let's also suppose their accounts earn an after-inflation 6.6% a year. This assumes the stock market delivers 7% a year, but investment costs snag 0.4 percentage point of that annual return.
At 6.6% a year, the $10,000 that I invested for each grandkid will be worth an after-inflation $463,000 after 60 years. What if I hadn’t bought the variable annuities, and instead they started on retirement saving in their early 20s? At that juncture, they’d be looking at perhaps 40 years of compounding. At 6.6% a year, $10,000 would grow to some $129,000, or 72% less than the $463,000 they’d have with the earlier start.
You could quibble with these numbers, especially the return assumption. Still, it’s clear that snagging an extra 20 years of compounding makes a huge difference.
When I was investing for Hannah and Henry, I didn’t just open variable annuities for them. I also set up taxable accounts where I invested money for a future house down payment. Later, when they had some earned income, I opened Roth IRAs on their behalf.
I would, of course, love to open Roth IRAs for my grandkids. Think about it: decades of stock-market compounding, all of it tax-free. It's a gift I'd love to see given to every young person—and perhaps the savings initiative launched last week will help to make that happen.
Unfortunately, at ages four and one, my grandchildren don’t have the earned income needed to qualify for a Roth. When they do, I hope their parents will remember this article—and open Roth IRAs on their behalf.
Jonathan Clements is the founder and editor of HumbleDollar. Follow him on X @ClementsMoney and on Facebook, and check out his earlier posts.The post When They’re 64 appeared first on HumbleDollar.
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