Opening a retirement account for your teenager while they are working summer jobs can be a highly advantageous move. According to certified financial planner Carol Fabbri, Roth individual retirement accounts are “triple-tax efficient” for teenagers. This means that Roth IRAs are funded with after-tax dollars, but teenagers often earn less than the standard deduction, which exempts them from owing taxes on the income used for contributions. Furthermore, Roth IRAs provide tax-free growth on investments, and withdrawals in retirement are generally tax-free.
If a 15-year-old were to invest $500 this summer, they could potentially have almost $10,000 when they retire in 50 years, assuming a growth rate of 6%. The key takeaway here is the power of long-term compound growth. Starting to save and invest early on can greatly magnify your returns over time. Despite more than 8 in 10 teenagers already thinking about retirement, it is common for them to mistakenly believe that savings is the best long-term strategy.
For minors, parents have the option to open a “custodial IRA,” which is a retirement account managed by the parent until the child comes of age. While there is no minimum age for Roth IRA contributions, children must have earned income from a job to qualify. The IRA contribution limit for 2024 is $7,000, but children cannot deposit more than their earned income for the year. Contributions for the 2024 tax year can be made until the tax deadline in 2025.
One of the advantages of Roth IRAs is their flexibility. The account owner can withdraw contributions at any time without incurring taxes or penalties. Additionally, there are exceptions to the 10% penalty on earnings withdrawals before the age of 59 1/2. Certified financial planner Tammy Wener highly recommends children opening Roth IRAs with their summer income. She personally provides a “match” to incentivize contributions for her own children, who each have a Roth IRA. However, it is crucial to note that the child’s Roth IRA contribution and parent match should not exceed the child’s earned income for the year to avoid the IRS penalty on excess contributions.
Opening a retirement account for your teenager while they are working summer jobs can set them on a path towards a financially secure future. Roth IRAs offer numerous benefits for teenagers, including tax efficiency, long-term compound growth potential, and flexibility in contributions and withdrawals. By taking advantage of this opportunity to introduce your teenager to the world of investing and saving early on, you can help them build a solid foundation for their financial well-being in the years to come.
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