Roth IRAs for teens pay off at tax time
Saving for a teenager’s retirement might sound far-fetched, especially with college costs looming. Who’s got time or money to be planning for the 2060s?
Yet setting up a Roth individual retirement account for your teen can be a smart and rewarding move to consider at tax time. You don’t have to be rich, either.
It makes good sense to set aside money that can grow many times over by the time it’s put to use. And establishing an IRA with a teen’s own cash — perhaps supplemented by Mom and Dad or the grandparents — can convey a powerful financial message that no pep talk could match.
A Roth IRA differs from a traditional IRA in that you contribute with after-tax money but pay no taxes on withdrawals, meaning all growth is tax-free.
As with Roths for adults, not every teen qualifies and there are strict rules. You can only open one if the child has income from a job — allowances don’t count. You can’t contribute more than the child made in any given tax year, up to the limit of $5,000.
Here are five reasons why a Roth IRA can be a good idea:
COMPOUNDING
Long-term compounding, or generating earnings from previous earnings, won’t necessarily make your kid a millionaire. But it could with future contributions.
Consider a hypothetical case in which $2,000 is put in a Roth annually for four years. Assuming the money grows at an annual rate of 8 percent, the account would total $456,000 in 50 years. And if the account-holder contributes $2,000 at the start of every year for 50 years, it would be worth more than $1.2 million.
JUMP-STARTS SAVINGS
Starting to save early for retirement is more important than ever at a time when the classic three-legged stool approach to retirement security — employer pension, Social Security and personal savings — is teetering.
Many college graduates focus on paying off their student loans. Starting retirement savings in their teens, even if they aren’t able to contribute much, at least puts some money to work early.
A Roth doesn’t lock up the money for decades. Once the account has been open five years, up to $10,000 can be withdrawn penalty-free if it’s put toward the purchase of a first home.
GOOD HABITS
Educating your teen about the value of compounding interest could be a lasting legacy if it fosters good habits. Teaching young people to put money aside regularly helps them better prepare for various life stages.
TAX ADVANTAGES
A teen working part time will have one of the lowest tax rates, making it a good trade-off to pay taxes on contributions now rather than accumulated savings in a few decades when the total and the tax rate will be much higher.
The tax-free withdrawals allowed with Roths mean having an account is a double winner for a young person.
SMALL AMOUNTS COUNT
Contributing the yearly maximum of $5,000 to a teen’s Roth, or even $2,000, just isn’t feasible for most families. But even a few hundred dollars can start snowballing.
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