Teenagers working summer jobs have a golden opportunity to start saving for their future by opening a Roth individual retirement account (IRA). These accounts are considered to be “triple-tax efficient” for teenagers, as explained by certified financial planner Carol Fabbri. Roth IRAs are funded with after-tax dollars, but teenagers often earn less than the standard deduction, which means they won’t owe taxes on the income used for contributions. In addition, Roth IRAs offer tax-free growth on investments, and withdrawals in retirement are generally tax-free, making them an attractive option for young savers.
The Power of Compound Growth
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 6% growth rate, according to Fabbri. The concept of long-term compound growth emphasizes that the sooner one starts saving and investing, the more significant the returns will be. It is crucial to instill the habit of saving and investing early on to benefit from the power of compound growth.
For children who are considered minors, parents can open a “custodial IRA,” which is a retirement account managed by the parent until the child reaches the age of majority. While there is no age minimum for Roth IRA contributions, children must have earned income from a job to qualify. The contribution limit for IRAs in 2024 is $7,000, but children cannot deposit more than their earned income for the year. Parents can make contributions for the previous year until the tax deadline in the following year, providing flexibility in saving for retirement.
One of the key advantages of Roth IRAs is their flexibility. Account owners can withdraw contributions at any time without taxes or penalties, with certain exceptions to the 10% penalty on earnings withdrawals before age 59 1/2. CFP Tammy Wener, a proponent of kids opening Roth IRAs with summer income, emphasizes the importance of incentivizing contributions. Wener’s own children each have a Roth IRA, with a parental match to encourage saving. However, it is essential to ensure that the child’s contribution and parental match do not exceed the child’s earned income for the year to avoid IRS penalties on excess contributions.
Opening a Roth IRA for teenagers with summer job earnings can be a valuable tool for long-term financial planning. By taking advantage of the tax benefits, compound growth, and flexibility offered by Roth IRAs, young savers can set themselves up for a secure financial future. Encouraging children to start saving and investing early on can instill sound financial habits that will benefit them for years to come.