Make Your Teenager a Millionaire with a Roth IRA

Did you know your children can contribute to a Roth IRA regardless of age? You bet your bottom dollar they can! Parents who are on track with savings may be looking for other ways to give their children a financial boost as they approach adulthood. Helping your children get a head start on saving for retirement can be a great strategy and this can be done in a tax-free environment such as a Roth IRA.

The Rules

Anyone of any age, as long as they have earned income and a social security number, can open a Roth IRA. Earned income or “compensation” includes wages, salaries, commissions, tips, self-employment income, professional fees, bonuses, and other income received for providing personal services. This can also include earnings from lawn mowing or babysitting as well. In short, if you earn it and you’re claiming it on your tax returns, then this would count as well. Have you ever thought of paying your child to clean your office? How about for assistance with stuffing and mailing envelopes? Heck, we’ve even seen clients pay their infant child a marketing fee for promotional use of their picture on a flier or business card just so they could start a Roth! A minor account of this type would need a Responsible Individual until the account holder turns 18, but otherwise a child’s Roth IRA has exactly the same rules as an adult’s.

The Magic of Compounding

The financial benefits of starting young are immense. Many people aren’t established in their careers or financially savvy enough to start saving for retirement until they are close to 30. If you help your children start saving for retirement early, they won’t have to save nearly as much later on. Let’s say for example, beginning at age 5, you take the $5 you spend at Starbuck’s each day and put it toward your child’s retirement. At that rate, you’d save around $150 a month for them. If they received 15 percent in compounding interest each year, they would have $42,028.70 after 10 years. After 20 years, they’d have $212,058.12 and after 30 years, when they are 35, they’d have an incredible $899,922.45. The power of compound interest is multiplied even further in tax-advantaged accounts, such as IRAs. For example, if you were to contribute $5,500 a year to a child’s Roth IRA and assume a 12 percent compounding interest rate of return for 30 years, their self-directed Roth IRA would be worth $1,486,609 at the end of the thirtieth year. Make the same investment in a non-tax sheltered environment (a brokerage account), assuming a 25% tax rate, and their nest egg would be worth $817,164 instead of $1,486,609. That is about 45 percent less – or a difference of $669,445. As you can see, the effect of taxes on your savings can be dramatic!

Do you want to know the best part? Money held in a Roth grows tax-free, can be distributed at retirement entirely tax-free, and can be passed on to the beneficiaries tax-free as well. In addition, any money in a Roth does not count toward financial aid calculations when applying for college either!

Who Should Contribute?

Many parents contribute to a Roth IRA on behalf of their children of all ages because they know they will not save on their own. If your 14 or 15-year old makes $2,000 in a summer, they generally don’t want to put that in a Roth IRA. They’re only thinking about the next iPad or video game.
A Roth IRA can be a great teaching tool and requiring teenagers with part-time jobs to put aside a percentage of their earnings teaches them the importance of saving and not spending frivolously. That way, they’re accustomed to saving by the time they get a job with a 401(k). If they are offered a company sponsored plan they’ll say, “Of course I’m going to sign up for this. I’ve been saving for my retirement my whole life.”

For maximum educational benefit, you may even consider offering to match your children’s contributions, to get them excited about watching the money grow.
Financial education such as this isn’t really taught in school, so it has to come from home. Teaching your children about tax-free compounding income in a Roth IRA is just a plain no-brainer!

By Matthew A. Tillack