Episode Transcript
Brenton: [00:00:00] People are saying that Blue Ivy is turning her income as a dancer for her mom into $6 million of tax-free investments. In this episode, I'll tell you how not only is that possible, but why $6 million may be a conservative number. Let's get started.
Brenton: Hello, my name is Brenton Harrison of New Money,. New Problems, and your host for the New Money, New Problems podcast. Today's episode's gonna be a unique one for [00:01:00] several reasons. The first reason being that we have told you over the course of the past several weeks that we are encouraging you all to reach out to us via email. Reach out to us on social media with financial concepts that you want us to cover.
So in this episode, for the first time, we're gonna cover a topic that was submitted by someone in our New Money, New Problems community. The other reason that I like this episode is because the concept that we're covering is kind of a blend of some other concepts that we've discussed in previous episodes.
Those being things like putting investments aside for your children, uh, how taxes work, how deductions work in pursuit of lowering your taxes. And all this came to be towards the end of last week when I had four separate people reach out to me with the exact same video asking if I could cover the topic that the person was discussing. And in the video, a woman is describing how Blue Ivy is getting paid to be a dancer for her mom and how she's somehow going to turn that dancing income into $6 million of tax-free investments.
If you're watching with us online, take a look. If you are listening to this podcast, [00:02:00] take a listen to this video.
Mrs. Dow Jones: Did you know Blue Ivy is turning her income as Beyonce's dancer into 6 million tax-free dollars during retirement? I'm Mrs. Dow Jones, millennial finance expert, and here's how the kids in your life can grow tax-free wealth too. Step one, get the child the job. In order for this hack to work, your child needs taxable income.
They could scoop ice cream caddy at a golf course, or if you have your own business, just hire them. That's what Beyonce and Jay-Z did. Blue has been on their payroll since she was born. No, literally, Jay-Z hired her at two days old to cry on his song Glory. Step two, open the Child a custodial Roth IRA.
These are the same as regular Roth IRAs. The contribution limit is the same $6,500 a year except their four kids, and you have to open it for them. Step three fund and invest the account. If Blue maxes out her custodial Roth contributions every year till she's 18, and it grows 8%, which is average for the s and p 500 and compounds annually, by the time she's 59 and a [00:03:00] half, she'll have over 6 million tax-free dollars and she'll only have put in $117k How nuts is that? Follow for more generational wealth tips and stay rich.
Brenton: All right, let's get into this. I really love this video because it allows me to cover someone else's content without criticizing that content.
Uh, if I ever criticize someone on here, I'll make sure to de-identify them. But this video, I actually agree with a lot of the concepts, so it's an interesting thing to dig into. So we're gonna go step by step through what this person is talking about and we'll tie it to concepts that we've covered in previous episodes of the New Money, New Problems podcast.
Let's do step one.
Mrs. Dow Jones: Step one, get the child the job. In order for this hack to work, your child needs taxable income.
They could scoop ice cream caddy at a golf course, or if you have your own business, just hire them.
Brenton: Step one is to get your child a job for this reason: we've talked about retirement accounts on this podcast, 4 0 1 Ks, 4 0 3 Bs. IRAs. In this example, a Roth individual retirement account. And [00:04:00] with Roth accounts, if you recall, you pay taxes when you put the funds in, and those funds grow tax deferred, meaning that as the investment balance increases, you don't have any taxable consequence as a result of that growth.
And then when you take the funds out in retirement, there are no income taxes. Why? Because the government either has to tax the funds when they're going in or coming out, but as long as you follow the rules, they can't tax you twice.
Now the other thing about these retirement accounts is that they have contribution limits. There are a number of benefits that are associated with them, and you can't just get those benefits for an unlimited sum every single year. The I R S tells you how much you can contribute, and with an IRA, it is the lesser of, in 2023, $6,500 or 100% of your pay. And that 100% is really important. As an example, let's say that you earned a hundred thousand dollars and you were eligible for a Roth IRA. You can contribute up to $6,500. But if you only earned a thousand dollars in 2023, you can't [00:05:00] contribute $6,500 because it exceeds 100% of your pay.
You would be limited to the a thousand dollars contribution. So the reason that the first step is to give your child a job is because in order to be able to contribute the maximum amount to a Roth IRA, they have to have enough income to justify the contribution, meaning they have to Earn in 2023, at least $6,500.
Now, the way that you pay your child is something that I don't think is very well covered when you see all these TikTok and Instagram videos because you can't just give your child $20 to sweep up around the house or clean up a little bit or run an errand and call that taxable income.
Why? Because the income is not registered with the IRS. It has to be something where they get either a 1099 or a W2. So they can work retail, they can work at a fast food restaurant. Or if you're a business owner, which is what you see in most of these cases, you can hire your child yourself.
As an example, one of my friends who sent me this has a wellness company and she has a young child and she had [00:06:00] joked around about a series with her child where they go through, The importance of movement and breathing and stress management in the workplace, or even at school for young kids. And she was saying, Hey, I'm gonna do this with my child.
You absolutely can. As long as you are running that through your tax professional, if you have a justifiable cause for employing your child, you can use that income as the means to contribute to that Roth IRA.
Now let's move on to step two.
Mrs. Dow Jones: Step two, open the Child a custodial Roth IRA.
These are the same as regular Roth IRAs. The contribution limit is the same $6,500 a year except their four kids, and you have to open it for them
Brenton: So what is a custodial Roth IRA as opposed to a Roth IRA? Well, a Roth IRA is an individual retirement account, and if you are going to be the individual opening set account, you have to be able to enter into a contract in this country.
If you are a minor, you cannot enter into a contract, especially a financial one, so you as the custodian have to open it [00:07:00] for their benefit.
So after the break, we'll cover a couple things. First, we'll go through step three and why that $6 million estimate that she gave for what Blue Ivy might have in retirement may be too conservative.
And then at the end, I'll tell you how it might be possible for not a single dollar of those funds to be taxed either when she takes them out or when they were put in.
[00:08:00]
Brenton: All right, we're back from the break. Let's listen to step three.
Mrs. Dow Jones: Step three fund and invest the account. If Blue maxes out her custodial Roth contributions every year till she's 18, and it grows 8%, which is average for the s and p 500 and compounds annually, by the time she's 59 and a half, she'll have over 6 million tax-free dollars. And she'll only have put in $117k
Brenton: Here's why I think this number could be too conservative or too aggressive, but the one thing I know for sure is that she can't say that she would have $6 million.
Nobody can, because we don't know what the [00:09:00] future of the market will be. If you look at the stock market or a segment of the stock market, like what she's doing by checking out the S&P 500 over a historical period of returns, 10 years, 20 years, 30 years, 40 years, you're going to find an average percentage return. Maybe it averages 10%, 5%, 7%, what have you. In this example, that average is a little over 8% per year. It might be up 24%, one year down 8% the next, and it averages out to 8% on a yearly basis. But it's not 8, 8, 8, 8, 8. Well, the shortfall of investment calculators and human beings is we don't know the future, so we can't say what the next 20 or 30 years of the market will give you.
So instead, they take that average, that 8% in this example, and they assume that you get that return every single year for however long you've put in that calculation.
So what this person has done is they've assumed that Blue Ivy is maxing out these custodial Roth contributions every year until she's 18 years old, which would total up to a little over [00:10:00] $117,000 worth of contributions.
She's stopping these contributions at 18 and she's assuming that those funds are going to get an 8% return every single year until the year that Blue Ivy turns 59 and a half, and when you plug in that calculation of 8% every single year, it would lead to a little over $6 million.
But if you're a fan of the show, you'll remember that we did an episode about a month ago where we talked about how it can be a positive for stocks to actually go down in certain periods of time. And the reason we said that is because if you're contributing to the market when it's low, the actual variations of the market can lead to a higher return at the end of a period than if you got that same return every single year.
As a matter of fact, if you're following along with us on screen, you're actually looking at a screenshot of what we covered. We went from the years 2001 to 2010, which was actually one of the roughest decades in the S&P 500 in recent memory.
Over the course of that decade, the average return was [00:11:00] 3.63%, and we compared what would happen if you put $10,000 in an account and credited that account at the actual average return of 3.63% per year to what would happen if you took that $10,000 and actually put it in the s and p 500 and had it rise and fall with that index, the way it actually performed. And what we found was pretty striking. 'cause remember, this is a decade that had the year 2008 in it. And in 2008, the s and p 500 had a negative 37% return.
So with that in mind, you would think that you would end up with more money by taking $10,000 and giving it a 3.63% return every year than you would by sticking it in the actual index and exposing it to that type of loss. But in actuality, at the end of 10 years, giving it a 3.63% return every year saw that $10,000 grow to a little over $11,500. But putting that $10,000 in the market and averaging a [00:12:00] 3.63% return led to a balance of a little over $14,200. So in this scenario, it actually benefited you to watch your money rise and fall with the market, and you ended up with more than you would have had you simply used an investment calculator and plugged in a return like she did in this scenario.
Now, is that a guarantee that it will happen? No. You could have a rough period of returns and it could not work out in your favor, but the point is, when it comes to compound interest and putting money in when the market is low, there is actually more opportunity to exceed what you would have as compared to an average return, and you can end up with something that's even bigger than what you thought was possible.
There are calculators that allow you to go back in time and put in a sum of money based on what the s and p 500 actually returned to see what you would've had a certain number of years later. We'll put a link to these calculators in the show notes.
And what I did was I went 59 and a half years in the past, and I assumed that in January of 1964, a theoretical blue [00:13:00] ivy was born, and at that time she started putting $6,500 a year into a custodial Roth IRA.
She does that for 18 years and puts in a little over $117,000 of contributions, and by January of 1982, she's 18 years old, and those funds have grown to a little less than $180,000. We then let those funds grow from her age 18 year, which in this example is 1982 until July of 2023, when she would've turned 59 and a half.
And what you find is that not only does she have more than $6 million, she has more than twice that amount. Just under $14 million is what these funds grow to over that 40 year period. Because when you look at what the s and p 500 actually returned, number one, that average during that period of time was more than 8%. That 40 year historical return was 11.07%. But in addition, the way that the market actually [00:14:00] moved allowed those funds to benefit from the volatility as compared to giving it an 11% return every single year. So again, there's no guarantee that this actually works in your favor, but when you look at the way the market actually moves, it is often more impressive than what we even think.
And lastly, as we bring this thing home, as we're talking about the possibility of it being not only $6 million, but potentially $14 million, how does Blue Ivy pay $0 in income tax on these funds? It has to do with something called the standard deduction.
So we talked about in our episode about how taxes work, which we'll link to in the show notes, the concept of a tax deduction and using it to lower your taxable income.
You should now be well aware that we don't pay taxes on every dollar of income that we Earn. There are tools that we can use called deductions that can reduce the amount of income on which we are taxed. Now, the standard deduction, and I'm gonna actually read the definition from NerdWallet and we're covering this on the screen, the standard deduction, and I quote, is a specific [00:15:00] dollar amount that the I R S lets you subtract from your Adjusted Gross Income to lower the amount of income you get taxed on.
How much of a standard deduction you're entitled to generally depends on your tax Filing status end quote. What they're essentially saying is no matter what's going on with your finances throughout the year when you have taxable income based on how you file, we are all entitled to a standard deduction, a set amount that we're able to use to reduce the amount of income on which we pay taxes.
In the year 2023. That standard deduction for a single person is $13,850.
So let's walk through this concept. If I Earn less than $13,850, there's a strong possibility I won't have to pay any income taxes. Because the amount I earned is exceeded by the amount I can use to reduce my taxable income that brings that taxable income technically in the negative, but basically to $0.
If my taxable income is $0, I won't pay any income taxes.
Now let's connect this to [00:16:00] the custodial Roth IRA. Let's say that I Earn less than the standard deduction, so I'm not going to have to pay income taxes on these funds, but then I Earn just enough to contribute the maximum amount to my custodial Roth IRA, meaning I earned at least $6,500.
I can take that taxable income, I can contribute it to the Roth IRA, and I didn't pay taxes on it because I earned less than the standard deduction. Those funds grow tax deferred, and because it's a custodial Roth IRA, when I pull it out, I don't pay taxes on those funds either.
That is how Blue Ivy can take $6,500 a year and turn it into six or even $14 million of income tax reinvestments. This is finances at work. These are the type of concepts that people use to separate themselves from the basic financial literacy that we see online and the level of financial literacy I want you to have as a first generation or second generation high income earner. I hope this episode was illuminating for you. I [00:17:00] hope it also encourages you if you have questions that you want covered to send them in so we can cover 'em on the podcast, and maybe next week we'll have a new question and answer segment just for you.
I'll see you then.
