I want to talk about retirement savings and helping your teenage child, grandchild or even a friend begin the long road to retirement on the proper foot. Now, I understand that the teens in your life couldn’t care less about saving for retirement, and that’s precisely why now is a great time to begin preparing, while time is on the kid’s side, by starting to build a Roth IRA with earnings from the upcoming summer and part-time jobs. Then, next March and April, you can tote up what Junior earned in 2011 and fund that IRA account for him or her before the April 15 deadline.
It would be nice if junior spenders could take this chore on themselves, but how many teens do you know who read investment newsletters? And if they did, where would they get the money to stash in an IRA? Most spend what they make, and then some. That’s why they invented parents (and grandparents).
I remember when I first opened an IRA for my then-teenaged son. Both he and my wife looked at me like I’d just announced we were moving to Siberia. The joke is on them, of course. By matching my son’s summer earnings and putting the money away in a Roth IRA, our almost-27-year-old has already built up a tidy sum that will continue to grow for many years to come.
It won’t pay for a nursing home just yet, but then again, he’s got a few years before that becomes an issue. And, he’s learned the value of early and long-term investing and compounding. My daughter’s IRA, smaller of course, is growing as well.
OK, that’s my kids. What about yours? Let’s review the teenage Roth IRA, so you won’t put this off. It’s important, and especially timely.
Rock and Roth IRA
The Roth IRA is an excellent retirement savings vehicle for younger people. Since their introduction in 1998, Roth IRAs have been garnering respect (and dollars) from knowledgeable investors for the advantages they have over traditional IRAs.
While a traditional IRA allows you to deduct your contributions pre-tax, it also locks your money in until you are 59 1/2 years old (unless you feel like paying a 10% fee on withdrawals, plus federal taxes), and forces you to take distributions upon reaching the age of 70 1/2, paying federal taxes at your future — and possibly higher — tax rate.
In contrast, when contributing to a Roth IRA, you invest with after-tax dollars now and can withdraw funds tax-free after the age of 59 1/2 or if you meet other IRS qualifications (for instance, if the distributions will be used for a first-time home purchase — something today’s kid might appreciate tomorrow — or to help with a disability).
Once you do hit retirement, there is no requirement on distributions for Roth IRAs. If you don’t feel like taking money out or don’t need it, you can leave it in there to continue growing.
Why am I so adamant that these are great starter investments for teenagers or young adults? Simple: taxes, and the power of compounding.
If your child is only working for the summer, or just starting their professional career, they will likely be in one of the lowest tax brackets, making it a fantastic deal to pay taxes on their retirement savings now as opposed to when they are older and in a higher bracket.
And, in this economy, many first-time jobs don’t come with 401(k) retirement plans attached, so there’s no means of forced saving for retirement. Plus, for most, an IRA gives you more flexibility in where and how to invest. On the other hand, 401(k)s often have few, and subpar, investment choices.