Q. I just heard about something that may fall into that too good to be true category.
Its called the Ricky Trust, and it is a way to save now for my sons retirement.
My son is only 10, and we have already saved substantially for his college, and this sounds like a great opportunity to help with his future savings. The example they give is saving $5,000 now for a newborn would provide more than $400,000 at age 65 assuming a 7 percent rate of return.
I understand that since my son is 10, Id have to put more money in the trust or, using the example, hed have to wait until age 75 to have the $400,000.
By using the Ricky Trust, all earnings are tax deferred, so no taxes are owed until my son takes a distribution at an age I establish for his retirement.
This sounds so much better than saving in a custodial account where hed have access to the funds at age 21, and under the new tax laws any income is taxed at my rate, not his.
So is this too good to be true, or some sort of a scam, or as great as it seems?
It is not a scam, but it is a clever way to market the sale of a variable annuity.
The trust is the brainchild of well-known financial adviser Ric Edelman. The official copyright name is The Retirement Income for Everyone Trust, RIC-E for short, pronounced Ricky. The trust is an irrevocable trust, so once you establish the trust, name your son as beneficiary and the age at which he can access the money, you cannot change the terms of the trust.
The RIC-E trust requires the age of distributions to be at least 59-1/2. The only way to access the funds before age 59-1/2 (or the age you establish) is if your son should become disabled or die before that age.
The investment vehicle used within the trust is a variable annuity. Variable annuities are a tax-deferred investment vehicle allowing various investment options, including stock and bond funds. Ordinary income taxes are owed on any distributions beyond the monies invested, and a 10 percent IRS early-withdrawal penalty is owed on gains if withdrawn before age 59-1/2. Variable annuities may have contingent deferred sales charges (the current one used for the RIC-E trust is 7 percent in the first year), commissions, annual contract fees, sub account expense fees and, since they are issued by insurance companies and provide some insurance benefits, they will have mortality and expense fees.
The statement that $5,000 would grow to more than $400,000 in 65 years is based on the assumed 7 percent rate of return used in the marketing materials. As with any investment, the amount after 65 years could be less or greater than $400,000 depending on the rate of return achieved after fees and expenses. The tax-deferred growth feature is a benefit of annuities, but upon withdrawal, all profits are subject to ordinary income taxes, not the currently more favorable capital gains tax rate.
If you are not concerned about continuing to save for your sons college and your own retirement, thinking about funding his retirement is very noble. There are many alternatives to the RIC-E trust that may be more advantageous, such as an outright inheritance, establishing a trust specific to your situation, and funding a Roth IRA.
Once your son has earned income, help him establish and fund a Roth IRA. There is no tax deduction for a Roth IRA contribution, but the earnings grow tax deferred and, including a few other exceptions, once the owner is 59-1/2, withdrawals are free of income tax.
As a comparison to the RIC-E trust, assume that you saved your $5,000 from birth until your son begins to work summers at age 16. After taxes, the $5,000 earned 5 percent for 16 years and is worth close to $11,000. You contribute $5,500 to his Roth IRA at age 16 and at age 17, it grows tax-deferred at 7 percent until he is age 65 and will be worth close to $300,000. All of this can be withdrawn completely tax free, whereas all the profits withdrawn from the RIC-E trust will be subject to state and federal income taxes.
If you select a low-cost mutual or exchange-traded fund, you will reduce your investment expense versus the RIC-E trust by at least 1 percent. Using an 8 percent rate of return in the above Roth IRA example, would provide your son with $460,008 tax free at age 69.
If you own your own business, talk to your tax professional about ways you could employ your son so he could have legitimate income at age 10, allowing you to fund his Roth IRA now.
Holly Nicholson is a certified financial planner in Raleigh. She cannot answer every question. Reach her at askholly.com or P.O. Box 97128, Raleigh, NC 27624