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The 5-Year Challenge

Teenage Waitress Working in Cafe Accepts 5-Year Challenge

Setting Your Child or Grandchild Up for Financial Success

One of the best ways to set oneself up for a lifetime of financial success is by beginning to save at a young age. However, many young adults entering the workforce have relatively low income, which can make it difficult to set aside money for the future. As a parent or grandparent, you may be wondering how you can help support the young adults in your life in saving for the future at a young age.

If you can afford it, try issuing your child or grandchild a “five-year challenge.” It works like this: you make a deal with your kids/grandkids that for every year in a five-year period that they max out both their Roth 401k ($22,500 limit for 2023) and Roth IRA ($6,500 limit for 2023), you’ll give them money to cover their lost salary.

There are three valuable benefits to this approach:

  • It allows the young adults in your life to fund their Roth accounts at a very low rate, given their low tax bracket.
  • If left untouched until retirement and invested appropriately, the Roth assets are poised to take advantage of compounding interest over many years, which can result the accumulation of significant assets over the course of your loved one’s career.
  • If married, you can use the annual gift tax exclusion to remove funds from your estate and provide those assets to your child or grandchild with no tax implications.

Here’s an example of how the five-year challenge can work.

  • Josephine, age 24, is single and working her first full-time job. She makes $45,000 per year, which places her in the 12% income tax bracket.
  • Josephine accepts her grandparents’ five-year challenge and contributes each month to both a Roth 401k and a Roth IRA at a rate that allows her to max out her contribution limits for the year.
  • Each month, Josephine’s grandparents gift her an amount equal to her contributions to replace her lost salary.
  • Over the course of five years, Josephine is able to save $145,000 of after-tax money in her accounts (assuming the limits remain the same from year to year). Because she contributed this money early in her career at a low tax rate (12%), she pays less in taxes than if she had contributed the same amount of money later in her career (when she would likely have a higher salary).
  • Given the benefit of compounding interest, if Josephine never contributed another penny to the accounts, her initial $145,000 investment has the potential to grow to $1,548,104.32 by the time she reaches age 65, assuming a 7% annual rate of return.1

However, it’s not only Josephine who benefits from the five-year challenge. Her grandparents, Lou and Mary, are able to use their gift as a tax planning opportunity. Here’s how.

  • In 2023, an individual can give up to $17,000 annually ($34,000 for couples filing jointly) per recipient without tax implications.
  • The gift tax exclusion means Lou and Mary are able to reimburse Josephine for the full $29,000 she contributed to her Roth 401k ($22,500 max) and Roth IRA ($6,500 max) tax-free.
  • Because the maximum gift tax exclusion is per recipient, Lou and Mary can simultaneously support other grandchildren in this manner, if they wish.
  • As long as Lou and Mary don’t give more than $34,000 to a single individual in a single year, they don’t need to file a gift tax return, and the gift is not counted toward their lifetime exclusion amount for estate planning purposes, thereby lowering the amount of their taxable estate.

Put simply, the five-year challenge offers valuable benefits for both the giver and the recipient. If you’re looking for a way to help the young adults in your life get off to a good financial start, this challenge may be a great solution.

Need some help getting started? Creative Planning is here for you. Our teams have experience navigating a wide range of tax and financial challenges, always aiming to helping clients achieve their long-term goals. For more information, schedule a call with a member of our team. 

This commentary is provided for general information purposes only, should not be construed as investment, tax or legal advice, and does not constitute an attorney/client relationship. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed.


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