Every summer, teenagers around the Tri-State experience the rite of passage known as ‘working a summer job.’ And while all that extra cash can come in handy for gas money or buying the latest and greatest smartphone, we hope they’re saving some as well – and saving it in the right place.
Save in a Roth IRA
While your first inclination might be to suggest your child save his or her earnings in a savings account, at Simply Money Advisors, we have a different suggestion: a Roth IRA. This is for a very simple reason – tax-free growth!
With a Roth IRA, any money that’s contributed grows tax-free. Then, once you’re 59 ½ and have held the account for longer than five years, all that money comes out tax-free. You can take contributions out at any time. (Other eligibility requirements also apply)
Lock-in tax rates now
A Roth IRA does not give you an up-front tax break, but you’re getting tax-free growth in exchange. Plus, your teenager is probably going to be in low tax bracket (or potentially not have to pay taxes at all), so an up-front tax break isn’t really needed.
Instead, a Roth IRA allows your teen to “lock-in” their low tax rate now… and not have to pay taxes on that money again.
Watch out for contribution limits
The only caveat is how much your child can save: he or she can contribute as much as they made for the year, up to $5,500. For example, if your daughter makes $2,000 lifeguarding, she can contribute up to $2,000 for 2018.
Another note: if your teen is under the age of 18, you’ll have to set-up a custodial Roth IRA account. This means the account is in their name, but you actually control it until they become a legal adult.
The power of time
Want an example of the power of tax-free growth?
Let’s assume your 15-year-old will retire at age 65. He or she makes a one-time contribution of $2,000, giving that money 50 years to grow. At an average annual return of 7% after fees, that $2,000 would eventually turn into almost $59,000 – and not a penny has to go to Uncle Sam when it’s taken out.
Kick-in a ‘match’
And here’s an idea. As a parent, “match” what your teen contributes! If they make $1,000 this year and want to save $500 to their Roth IRA, kick-in another $500. Again, the total amount contributed for 2018 has to be either $5,500 or how much income they earned for the year, whichever is less.
The Simply Money Point
While your teenager might not be thinking long-term right now, try your best to help nudge them in the right direction by using a Roth IRA to save any earned income. It’s a fantastic, tax-advantaged way to get your child saving for the future.
And to help you learn more retirement planning, you’ll find free downloadable guides and online tutorials in our new “Retirement Resources” library!