In 2002, I read Kevin McKinley’s book: Make Your Kid a Millionaire: 11 Ways Anyone Can Secure a Child’s Financial Future. One suggestion is starting an IRA for your kids when they start working.
Retirement planning for a 14 year old? Sounds like a crazy idea. But look closely at the math and you’ll realize those small contributions grow the most.
The reason this works? The amount of time the investment grows. Remember that Einstein is sometimes credited with declaring, “Compound interest is the most powerful force in the universe.”
Why not put this force to work in your family?
Since many teens are starting their first job this summer or working more hours now that school is out, let’s look at why a working teenager should have a Roth IRA.
1. Good habits start early.
Teaching a working teen to budget their income is a good lifetime habit. Under the three big categories of Give, Save and Spend, a Roth IRA contribution falls under the Save area.
The Average American only has $35,000 in retirement savings and saves around 3.7% of their income. That is way short of the advised 10-15% for retirement savings. Start a teen putting aside 10% or more for retirement now, and hopefully the habit will continue when that $200 paycheck becomes a $2,000 paycheck.
2. Time – the most important reason!
Small seed contributions today will become mighty retirement redwoods. Contributions in a Roth IRA during the teen years will be the portion that grows the most over the next 50 years. Time is one of the most important elements of a successful retirement plan.
Example 1 from My Nephew’s Summer Internship
Ethan, age 16, contributes $500 from his summer internship over the next five summers. That $2,500 at 8% conservative growth will become around $137,000 at age 65.
If Ethan is able to put aside $1,000 over the next five summers at 8%, the balance will be around $275,000. A quarter million dollar retirement for the price of $5,000. That’s a big deal!
Example 2 from David Bach’s Automatic Millionaire
Terry contributes $3,000 a year from age 15 through 19 at 10% return and has a balance of $1,615,363 at age 65 from $15,000.
Kim starts contributing $3,000 a year from age 27 until age 65 and only has a $1,324,778 balance after $117,000 in contributions.
Example 3 from Financial Peace University
Ben, age 19, contributes $2,000 to a Roth IRA for 8 years at 12% growth. At 65, the account balance is $2,288,996 from $16,000 in contributions.
Arthur starts contributing $2,000 from age 27 through age 65 and has an account balance of $1,532,166 from $78,000 in contributions.
As you can see, time plays a very serious, important role in investment growth.
3. Pay little or no taxes now for a tax-free retirement.
A teen’s annual income typically falls within the lowest tax bracket – essentially making these working years the lowest taxed of their lifetime. It can also fall under the standard deduction so that very few taxes are paid at all beyond Social Security and Medicare contributions.
By contributing to a Roth IRA, your teen can have a nearly tax-free retirement contribution and growth. Withdrawals in retirement will be tax-free during a time when their income and the tax brackets will be higher.
4. Flexibility with life’s choices.
Starting a Roth IRA in the early working years gives flexibility down the road.
Stay-at-Home Parent
A stay-at-home parent will have financial peace of mind while they do the most important job in the world knowing their retirement is still growing. Even though a SAHP is eligible for a spousal IRA, the household budget might be tight on a single income for a few years with little or no extra for retirement savings.
Low-Paying Vocations
We all want our children to find and follow their passions in life – but many do not come with a high-paying job or a retirement plan. A Roth IRA that builds over 60 years with small annual contributions can grow into a decent retirement asset.
Disability
Pre-retirement age adults have a greater chance of becoming disabled than dying. Putting money to work early in a Roth IRA helps lower the risk of not having any retirement savings because you had to stop working right at the time when you were planning to start putting money aside.
Caretaker
Your teenager, in their adulthood, may have to choose between caring for someone or working. They might want to be a SAHP, homeschool their children, provide long-term care for a child with different abilities, and/or help with aging parents or other family members. Having a Roth IRA that continues to grow during those exits from the workforce can be a comfort.
How a Teen Can Open and Contribute to an IRA
Opening a Roth IRA Account
Since a teenager is a minor, an adult will have to help open a Roth IRA account as the custodian. In most states, the adult will have control over it until the teen is at least 18 years old. Vanguard has a $1,000 minimum deposit on an IRA account with limited investment choices but other companies offer a low-opening deposit with automatic monthly investing.
You need to research to find the right mix of investment options, low opening balance requirements, and management fees.
Teen Contributions
The working teen can set aside a portion of every paycheck to contribute to the IRA. A general rule of thumb for adults is 10-15% of take-home pay.
Matching Contributions
You may encourage your teen to put money in an IRA by matching your contributions. Talk about whether you are interested in matching 5-100% of their contribution to help kick-start their IRA.
Parent/Grandparent Contributions
Some teens receive gift or spending money from their parents or grandparents during the year. Their IRA contribution doesn’t have to be directly tied to their paycheck – the only rule is you can’t put more into your IRA than you earn up to a maximum of $5,500 in 2013.
This is a great way to pass down wealth without inheritance taxes.
Final Thoughts
Our teens have been working and building up a Roth IRA balance for the past nine years as part of our family’s big picture financial plan from a variety of contribution sources. While a portion of the contributions are from us, we feel like the gift of time and tax-free growth is worth more than the actual money given.
What would you tell a teenager about saving for retirement? Does a teen in your home have an IRA? Leave a comment!
