Setting up a Roth IRA for your child can be an excellent way to support their future financial freedom. By demonstrating the importance the investing to your kids at a young age, you're helping them to develop financial skills that will last a lifetime.
Today, we're interviewing a father who's actually put the Roth IRA to use for his daughter. Doug Nordman is the author of The Military Guide to Financial Independence and Retirement and the founder of the website The Military Guide. After serving 20 years of active duty in the US Navy, Doug retired in 2002, at the age of 41. Doug's financial expertise has been featured in major national publications like MarketWatch, Business Insider, and CBS News.
Andy Hill: When did you start talking to your daughter about money?
Doug Nordman: We probably talked with her as soon as she was able to understand our vocabulary about it. I'd say we probably began around age two. As soon as she stopped putting money in her mouth, we felt like she was old enough to handle it.
Did you guys do chores or allowance?
Yes. As soon as she was 3 or 4 years old, we started an allowance. And the whole idea is not to enrich your kids or to turn them into savers as much as it's just to teach them how to take care of money. They have to manage money before they know how to save it or invest it. And so we started giving her an allowance at the age of three or four.
We also read books that really gave valuable advice. One of the favorite ones, it's a classic now, is David Owens, First National Bank of Dad. In there he talks about how kids basically think their parents are crazy. The parents take their money away from the kids and they never get it back to him. They say for this thing called the college fund, which is like three lifetimes away when you're a six-year-old.
So the whole idea is to align the kids' financial motives with yours. David Owens used to do it by bribing them, essentially. He asked them if they wanted to deposit their allowance in the Bank of Dad and the Bank of Dad paid a ridiculous sum of money. If I remember right, it was something like a nickel per dollar per month. I mean it made a lot of sense to him. Everybody wants to invest with the Bank of Dad and so we did something similar with our daughter.
We started her off with a penny per dollar per month, but we taught her how to manage money and we'd read books that would really rev up her imagination. There was a great book I remember in kindergarten called If You Made a Million, and it was just a kids' book, but it showed what a million was and asked you to imagine what you could do with that.
So all the way back, as early as preschool, she was getting an allowance to learn how to manage money. You got an allowance in our family just for being a good member of the family, for doing your chores. Again, the whole idea here is to get kids to manage money. And David Owen talks about how it can get scary early on. They're running around the house with money and they really have no idea what they're doing, making mistakes.
He tells parents to think of it as giving kids a $20 bill and having them light it on fire and waved around the house. That's how they learn, by making those mistakes. So once she learned how to handle an allowance and we started adding in the idea of jobs – but you can only do jobs after you've done all your chores. Once you've done all your chores, now you can earn the extra money from jobs. We've always tried to give her a financial motive to have her want to earn money, get more money, save her money, invest her money, whatever she wanted to do with it.
Related Podcast: Why Parents Shouldn’t Tie Allowance to Chores – with John Lanza
Was this something your parents did for you?
I wish this was discussed in my family growing up. Money, as with many American kids in the '60s and '70s, was a topic that you just didn't discuss because it was rude.
‘Revenge parenting' is when you're raising your kids better than you were raised. When our daughter was born we realized we really should have some idea for her on how to learn how to manage money. So we looked for those books, we found them, we read them and we used them. We wanted to help her avoid making the same mistakes we had made with money when we were younger and get her off to a good start.
What age did you start the Roth IRA for her?
Well, in Hawaii, a teenager can get a work permit when they turn 14. She had spent many years before this going to a tutoring service called Kumon – learning centers on the mainland. She'd been learning math and reading at Kumon, but the Kumon franchise owner had been dropping a lot of hints at when Carol was 14 years old that she'd be ready to get a job at Kumon. Miss Amy ruined the market for us parents because Carol started earning something like $7 or $8 an hour – way more than we could afford to pay our child labor.
The day she turned 14 she got a work permit. She got her W2, she started earning an income and then the following January or February, I think it was, we started her Roth IRA. She had a birthday in October and we started a few months after that because she finally had enough savings.
I don't think she maximized her contributions the first couple of years. If I remember right, we had to start the Roth IRA the second year, in January. That way we could make a contribution for the previous year with some of the current year's income. But it all works out on income tax return. We made sure to declare the amount of money that she earned not just from her job, but also from working around a house and all the other jobs she did. She also helped manage a rental property.
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You want to give your kids as much money as possible to put into that Roth IRA, and you can do it legally and ethically. We did that and I think she was putting all of her employment income into her Roth IRA. I remember the discussion back then was: “Yes, I know you want to have some fun with some of this money, but for every dollar you put into that Roth IRA, you will be getting closer to the limit that you're allowed to have for contributing to it.”
We kept that up during high school. She kept it up during college with the money she was earning at part-time at college. And of course, once she graduated from college and got herself a job, she kept it up during her working career.
And how old is your daughter today?
Now she's in her late 20's.
She just finished her 5 years of service of active duty in the Navy and this month she transferred to the Navy Reserve. She's been contributing to her IRA and to her military 401k the whole time. All of her working years since college.
Do you know much she's accumulated in her Roth IRA since age 14 up until today?
No, I haven't asked. I'd have to check in with her on that. She was probably maxing out around 2008/09, and in '08/'09 those dollars are buying a lot more shares today.
In 2008/09 she was 14/15 years old, and she was kind of concerned that Mom and Dad might not really understand what was going on in the stock market. But we kept her with it and I think she was maximizing a Roth IRA every year from 2010 up through today. So that's 9 years right there.
Does your daughter have aspirations for financial independence like you?
We had financial independence when she was only 9 and a half years old. That's when I retired from active duty, and she's had to put up with this for 2/3 of her life. She keenly understands financial independence.
At one point we had a deal where when she was in middle school and sitting at the bus stop waiting for the school bus, I would not drive by in the car with a longboard strap to the roof heading for the beach. She understands the lifestyle, she's motivated and she can do the math. One of the best things about the blog is she can refresh her memory and read that stuff anytime she wants to without having to listen to a lecture from Dad.
She's committed to maximizing her retirement accounts and contributing even more to taxable accounts. She has a pretty high savings rate from what she tells me and I'm pretty sure that she's enjoying work. And she's leaving active duty for the navy reserve as a whole new life for her. She and her husband are joining their career, but she knows financial independence. It gives you choices and she can decide if she wants to keep working or she can decide if she wants to do something else.
Your financial independence came from the pension, but also savings. Is that right?
That's true. But before people start racing down to the recruiter's office, I'm going to put it in a disclaimer here that only one out of six people that joins the military actually makes it to 20 years to retirement. Most people do one or two obligations and then get out of the military.
But the 6/8/10 years you spend in the military give you life skills and you do get some military benefits. If you're challenged and fulfilled and you like what you're doing in the military, it's great if you reach the 20 years. You can reach financial independence easily with a military pension and the cheap healthcare, but you can also reach financial independence while you're on active duty, even before you get to the pension.
I have a few readers who are big savers and they email me and say:
“Look, I'm at 15, 16 years of service. I know I could go to 20 but I'm already financially independent and I'm ready to do something else. So can I work that out?”
The answer is a big YES. It takes all skill levels and all types of savers in the military, you don't have to go for the pension. You can do it with just the skills you get from one obligation.
Related Interview: Finding the Right Savings Rate for Your Family's Financial Independence
If you could start the process over again, what would you have done differently with your daughter's Roth IRA?
It was 2006 when she started and it was hard to find a custodian for a Roth IRA for a minor. In fact, I argued for several years with Fidelity and it wasn't until she turned 18 years old in 2010 that she could transfer her funds to Fidelity.
Now today, today they'll sub-custody a Roth IRA for a minor. Maybe it was me, but I think they finally recognized their demographic and their customers. We also had a high minimum. You had to have something incredible like $1,000.
Today, if I was a brand new blogger, or if I knew there was a way to pay her a reasonable sum of money for doing something, now you know. Clearly, you're not going to pay a nine-month-old baby, $6,000 a year. The IRS could probably catch on to that fairly quickly. But many child models get paid a photo appearance fee.
Many young kids can help with things like setting up your podcast gear or helping you edit the video. Older kids can work a blog or writing tools or whatever they want to do. Any of that income that you feel that they have earned income at, they can contribute to their Roth IRA.
If there's not a minimum to make, you know, like $1,000 or $3,000 for some Vanguard funds, then it's a great deal. You can start that Roth IRA early. It's all about the compounding. The high savings rate is great, but if you're starting someone off in their middle school years, then by the time they're at college they'll be in great financial shape.
For those who think we're at the top of the market and don't think it's a good time to invest, what would you say to them?
There's a graph that shows that there's like 10 different peaks. Every peak is higher than the last peak, and every time you're investing in a stock market, it's a scary time to invest. It's either in a recession and there is no way you're going to invest “because the market's going to zero”, or it's a bull market and there's no way you're going to invest because “it's at the peak and it's going to collapse tomorrow”.
The only advice I have is to take a long term perspective. It's money you're not going to need for 10 years. Ever since we've started taking data about the stock market, it has achieved a positive return. Now, those first 8 years of that 10 year period might have been scary, but every 10 year period in a stock market, it has had a positive return, especially with reinvested returns.
So I say, stop worrying about what the market's gonna do tomorrow. Focus on your career, focus on self-improvement, focus on your education, focus on promotions and earning more money. But keep investing. Put that investment on autopilot and contribute as much as you can. You know you're going to live frugally without depriving yourself, but you're going to contribute as much as you can. The higher your savings rate, the more it's going to compound. It's all long term money; you're not going to need this for at least 10 years, so you will earn a positive return on it.
Where's the best place for people to open a Roth IRA for their kids?
Back in 2006 we were using clay tablets, wooden styluses and carrier pigeons. It's way better now, and a lot easier.
I would just go with one of the big three:
They've all got good funds, they've got low expense ratios and they've all got plenty of educational material there. The key here is to align your child's priorities with their financial incentives. You've got to get them to invest, but you also got him to leave the money in there and not cash it out for a really good party during their sophomore year in college!