As a member of Zonta Key West, I am pleased to be participating in JOURNEY TO SUCCESS, PART 2 on Saturday, June 25th. Our goal is provide business skills to assist girls and women in their journey to career success.
In this morning session we will be covering time management and money management skills. We will discuss banking basics such as how to open and maintain a bank account; apply for a credit card or a mortgage. In addition, we will review the rules of thumb that apply to maintain an emergency savings fund based upon her income, the maximum amount of pay for rent or to incur for a mortgage.
Not surprisingly, my job is to discuss the growth of money. So we are going to tackle a basic money concept that everyone should have learned in their math class in high school, but rarely do, the compounding of money.
A traditional IRA provides a tax deduction and the growth of earnings on a tax-deferred basis. Under current regulations, once one reaches age 70.5 years, they must start to withdraw funds which are taxed at ordinary interest rates.
I really encourage young persons with any earned income to open a Roth IRA instead; they are special in that the principal and earnings grow tax-free for life! Dependent children who start working do not have to pay taxes if they earn less than $6,300 in a calendar year. They have a zero tax rate so they don’t need the tax deduction.
For example let’s look at your 17 year old daughter in her first job. She saves $1,000 the first year. Assume she opens a Roth IRA with those funds and it is invested in the stock market which earns an 8% annual return until she reaches age 70. That $1,000 grows to $477,000 and it is tax free on withdrawal!
Later she gets a good job and at age 25 starts saving for retirement in her Roth IRA. She saves $3,000 a year until age 70. Wow, at the same 8% annual return she has accumulated $2,529,590 in her account and it remains tax free! Of course she could save more; the current maximum annual contribution for an IRA is $5,500 and $6,500 if you are over age 50.
Compound interest provides for wealth creation. But it also can work for wealth destruction if you incur debt and repay it over long periods of time. Let’s look at an example. Your daughter decides to go on vacation to California for a week; she borrows $3,500 on her credit card to do so. If the interest rate she pays compounds monthly at 17% and she takes 7 years to pay it off, the trip will cost her $18,932! Ouch, that was a very expensive trip that cost her over 5 times the amount she borrowed.
Unfortunately, in 2015 the average American family had $15,762 in credit card debt. If we assume they carry this average balance for 30 years at 17% interest compounded monthly they will spend $2,494,427. Almost $2.5 million went to their credit card company instead of funding their financial goals! These companies bank on the fact that Americans don’t understand how compound interest works.
Understanding compound interest can assist your daughter in making important decisions about saving, investing, retirement planning, purchasing cars, and her home. Let’s make sure you share this concept with her!