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If you're in a position to help a younger or lower-income worker in your family but don't like the idea of a direct hand-out, consider kick-starting his or her retirement. A 25-year-old saving $4,000 a year through age 35 in a tax-deferred retirement account would have more than $1 million by age 70, assuming an average rate of return of 8 percent. That's compound interest at work.
We've written about some of the tax breaks the IRS offers to lower-income workers who make contributions to IRAs. (You have until the tax deadline, April 17, to contribute for tax-year 2011.) The tax advantages are especially potent when the investments trigger the IRS's Savers Credit. These workers not only get a leg up on retirement; they also may be able to cut their federal income taxes to zero and get a nice refund.
Anyone receiving an IRS Form W-2 can save in an IRA. That includes minors earning money from, say, summer lifeguarding or bagging groceries after school. You can only contribute up to the amount earned. Cash doesn't count unless the child files a tax return reporting it, according to the IRS.
As to where to put that money, my colleague Chris Horymski notes that while many investment companies require a initial investment of $2,500 or more for taxable accounts, they'll lower that floor to $500 or less for new IRAs. Vanguard's low-cost STAR Fund, for instance, accepts initial investments of as little as $1,000.
For now, we'll leave aside the argument that a younger worker might prefer help paying down student debt. Or the risk that someone 18 or over with direct access to that money might just take it and run. Let's just say that under the right circumstances and with the right recipient, this type of gift could be well appreciated many years from now.
—Tobie Stanger
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