My cousin and her family recently deserted Long Island for Wake Forest, North Carolina. This was the first time in nearly 10 years that Mrs. Groovy and I celebrated Christmas with them, and we decided to mark the occasion by getting each of their two small kids a gift card.
But soon after we purchased the gift cards, we had buyer’s remorse. These two small kids are already buried in stuff. They didn’t need the means to buy another video game or doll. So Mrs. Groovy and I blew it for this Christmas. We didn’t use our values to guide our gift-giving. We used our desire for convenience instead.
But what if we hadn’t been pressed for time? What if we had tried to get them gifts that reflected our values? What could we have gotten them?
After a little thought, Mrs. Groovy and I decided that rather than giving the gift of stuff, it would have been much more preferable to have given the gift of compound interest. Of course, to a five and seven year old, the gift of compound interest is about as joyous as a donation to the Human Fund made on their behalf. In other words, it sucks! Big time. But given their circumstances (they’re the children of very affluent, very consumption-minded parents), it’s the gift they need. Now the only question Mrs. Groovy and I have is this: how do we give them the gift of compound interest next year?
Fortunately for Mrs. Groovy and me, we have options. SparkGift, for instance, is a company that allows you to buy fractional shares of a stock or index fund and give those shares as a gift. For as little as $20, for instance, you can buy a fractional share of Disney stock in the name of a child. Not too shabby.
Another, more elaborate way to give the gift of compound interest is the RIC-E Trust (pronounced “Ricky”). RIC-E Trust stands for retirement income for everyone trust and was invented by Ric Edelman. From what I can gather, it works pretty much like an IRA. You create the trust for a child and any money placed in the trust grows tax free. The child, in turn, may withdraw money from the trust without penalty once he or she turns 59½. But it costs $400 to setup the trust; the minimum investment is $5,000; and the trust money is invested in a variable annuity.
Can’t We Make Things Easier?
Okay, next year my cousin’s two small kids are getting fractional shares of Disney stock. Getting a RIC-E Trust set up for these kids is obviously above my pay grade. That’s a job for my cousin and her husband.
SparkGift and the RIC-E Trust are very creative ways to fill a void in our investment landscape. They allow FI yahoos like Mrs. Groovy and me to give the gift of compound interest to a child. But they’re both clunky tools at best. What’s to stop my cousin, for instance, from selling the fractional Disney shares I buy her kids? And compare the start up costs of a RIC-E Trust to a Roth IRA. For a RIC-E Trust, you need a lawyer and $5,400. For a Roth IRA, you need an internet connection and as little as $100. Now, am I missing something here? Why are we making this so hard? Don’t we want millions of little Warren Buffets to bloom? Can’t we make it easier to give the gift of compound interest?
The problem is that our best tools for taking advantage of compound interest are decidedly work-centric. In order to fund a Roth IRA or a 401(k), for instance, you must have a job. This naturally poses a problem for children, who, quite understandably, aren’t allowed to work. It also poses a problem for adults who want to help children. Wouldn’t it be great, then, if we could create a tool for taking advantage of compound interest that isn’t work-centric—that was designed specifically for children and their benefactors? Enter my invention: the Junior IRA (JIRA).
A JIRA (pronounced ji-rah) is merely an IRA for minors. And here’s how I would design it if I were the Grand High Exalted Mystic Ruler of the United States.
- Once established by law, every newborn in the United States would leave the hospital with a birth certificate and a JIRA.
- The newborn’s parents or guardians would have the authority to choose the JIRA’s custodian (Vanguard, Fidelity, Schwab, etc.).
- The only eligible investment option for a JIRA would be a low-cost, total-stock-market index fund (Vanguard’s VTSMX fund, for instance).
- The federal government and the birth state would each be required to contribute $1,000 to every newborn’s JIRA. Since there are roughly four million babies born in the United States every year, this feature would cost roughly $8 billion dollars annually (four billion from Uncle Sam and four billion from the states). Eight billion dollars is, of course, a lot of money. But in the context of what the feds and and the states currently spend (over $4.6 trillion annually), it’s coins beneath a sofa cushion.
- The maximum contribution to a JIRA in the first year of a child’s life would be $3,000 ($2,000 from the government and $1,000 from other sources). The maximum contribution after the first year would be $1,000 annually.
- Contributions to a JIRA could come from any source (parents, grandparents, aunts, uncles, charities, foundations, churches, etc.) and could not be used by the contributor for a tax deduction.
- As soon as a child turned 18, her JIRA would immediately convert to a Roth IRA.
Now suppose a child’s JIRA was fully funded by her family for 18 years. When this child turned 18, she would have at least $20,000 in her JIRA. If she added nothing to her JIRA-converted Roth IRA throughout her working life, how much money would she have in this account at 65? Assuming a return of 8 percent, she would have $744,640.17. If she contributed just $100 a month to her Roth IRA over her working life, she would have $1,331,598.83. If she contributed the current maximum to her Roth IRA every year until 65 ($5,500), she would have $3,434,847.58.
To me, the Junior IRA is a no-brainer. Not only would it encourage saving and get the power of compound interest working for our children as soon as possible, it would also provide our Social Security program with some much needed relief. Think about it. As the above numbers show, any American who reached her 18th birthday with a fully-funded JIRA ($20,000 in contributions), and who made modest but disciplined contributions ($200-$300 a month) to her JIRA-converted Roth IRA over the next 47 years, would easily amass a couple of million dollars. This small fortune would be in addition to any pension, 401(k) balance, or home equity she managed to build up over the years. Now assuming that the American just described becomes the new normal, very few future Americans will be dependent on Social Security. For most Americans, Social Security will be fun money—money to use for travel, Vegas, or even funding their grandchildren’s JIRAs.
But just because I find the JIRA to be a no-brainer doesn’t mean it’s free of problems. Here are some major problems that would need to be addressed.
Inequality. Too many children in this country are born into poverty. And while having lots of poor children with JIRAs—and the $2,000 in taxpayer contributions that come with those accounts—is infinitely better than any wealth-creating tools currently available to poor children, JIRAs will not sit well with many people. Why? Simply put, wealthy families will be able to contribute to their children’s JIRAs and poor families won’t. JIRAs will exacerbate income inequality.
One way to mitigate this concern is to allow anyone or any institution to contribute to a poor child’s JIRA. Our public schools, for instance, could be a great source of JIRA contributions. Imagine a school board for a poor district. Every year it proposes two budgets. One with no JIRA contributions, and one with, say, a $250 JIRA contribution for each student. Both proposed budgets cost the same. The budget with JIRA contributions, though, contains some sacrifices. The average class size is increased by five students and most of the after school programs are cancelled. Would parents and taxpayers find these sacrifices tolerable? Maybe. Maybe not. The point is that once JIRAs become part of the equation, board members, teachers, parents, and taxpayers would be hard pressed not to weigh the value of JIRAs against their current spending priorities. My guess is that they will find maintaining the quality of their schools and making JIRA contributions are not mutually exclusive.
Fear of Wall Street. Wall Street does not have a pristine reputation. And rightly so. You repeatedly mistreat the public (Bernie Madoff, Enron, collateralized debt obligations, robo-signing foreclosures, high-frequency trading, 12b-1 fees, hostility to the fiduciary standard, etc.), and you forfeit all trust. JIRAs, then, can’t become a new way for the ravenous wolves of Wall Street to feast upon lambs.
To guard against this threat, I proposed a couple of investment restrictions for the JIRA that should keep the wolves at bay (see bullets two and three above). But children aren’t the only ones who need protection. Adults need protection too. So to keep JIRA-derived Roth IRAs less susceptible to the avarice of Wall Street, I propose the following investment restrictions for JIRA-derived Roth IRAs.
- Only three types of funds can be part of a JIRA-derived Roth portfolio. A domestic total stock market fund, an international total stock market fund, and a domestic total bond market fund.
- All funds purchased through a JIRA-derived Roth must be low-cost index funds or ETFs.
- Finally, an age-based minimum bond allocation is required. Those forty and older must have at least 20 percent of their JIRA-derived Roth portfolio invested in the bond fund. Those fifty and older must have at least 30 percent. And those sixty and older must have at least 40 percent.
Anchor babies. We can’t be the world’s Department of Health and Human Services. In other words, we can’t afford to give $2,000 to every baby born to a non-citizen in this country. Failure to exclude anchor babies from the JIRA program would not only encourage more illegals to flout our immigration laws, it would completely undermine support for the program.
Those born before the advent of the JIRA. Suppose for a moment that Congress creates the JIRA and the program begins in 2017. Every newborn from that year forward would leave the hospital with a JIRA containing $2,000. But what about children born in 2016 or before? Giving $2,000 to every minor born before 2017 would probably be too costly. But every minor born prior to 2017 should be able to start a JIRA. And anyone who has a JIRA should be eligible for the maximum lifetime contribution of $18,000. So if a 16 year old gets a JIRA in 2017, her family’s contributions would not be limited to $2,000 ($1000 for 2017 and $1000 for 2018). Her family would also be allowed to make an additional $16,000 in “catch-up” contributions ($1,000 for every previous year in the child’s life). If she began her JIRA at six rather than sixteen, her family would be allowed to make $6,000 in catch-up contributions.
Compound interest is a very cool thing. So cool, in fact, we shouldn’t keep it away from minors. An American’s investment career shouldn’t begin when she gets her first job at 16 or 18. And it shouldn’t be left to chance. It should begin at birth; and it should be automatic. JIRAs will make this happen. The status quo won’t.
So what do you think of my JIRA invention? Would you like to have one for your child? Do you think anyone in Washington would be interested in it? Please leave comments. I’d love to get a discussion going with the FI blogosphere.