As you read this, you may think, “Summer is almost over.”
That doesn’t change anything. Believe it or not, it’s not too late to take full advantage of this summer job opportunity. In fact, you probably have until next April to make a final decision.
Unfortunately, most often summer jobs teens think only of short-term goals like money for a movie, buying a car, or even paying for college.
Those who have the future in mind, however, understand the true long-term benefits that summer work offers. Earnings for teens qualify for contributions to the IRA, and this can bring huge returns when your child retires. For example, savings in the maximum annual contribution to a Child IRA ($ 6,000) increase each year from age 13 to 18 to $ 2.5 million at age 70 (assuming an annual growth rate of 8%).
This is not rocket science. It is direct mathematics that everyone can understand.
If it’s that simple, why doesn’t everyone do it?
Retirement advisor Jonathan DeYoe, president of Mindful Money in Berkeley, California, uses this approach. He has two teenagers and has founded Roth IRAs for both. He is one of the few financial professionals who understand the importance of the Child IRA and have quickly seized this opportunity for their own children.
Still, DeYoe notes that many parents don’t do this for a variety of reasons. “They’re bad enough at funding their own IRAs,” he says, “and they don’t know it’s an option.” Further, he adds, “Their advisors don’t think about the very long term (or don’t understand the incredible power of funding a Roth IRA for a 12-year-old, or 60 years of composing).”
Of course, the seven-figure increase in retirement at the age of 70 sounds incredible even to you, but you may be worried that this pot of gold at the end of the Child IRA rainbow lies too far in the distant future to entice your child. Do not worry. Most children are impressed by the five-figure amounts in dollars, and this can be achieved in a short period of time.
Speed is most important for the lesson to return home. The Child IRA is fast becoming an educational tool (regardless of your child’s age).
“They learn about the power of saving and the power of composing,” says Arvind Wen, CEO of Capital V Group in Cupertino, California. “If they can learn discipline through delayed gratification, it will be an added bonus for them. If the funds agree even in single-digit percentages on average each year, they could get a seven-digit nest (tax-free if Roth’s) on retirement. “
While you shouldn’t give up on the growth aspect of using your teen’s summer earnings to start funding a Child IRA, these vehicles offer a host of other rewards.
“There are a lot of benefits for younger people to open Child IRA accounts,” says Jason Field, a financial advisor at Van Leeuwen & Company in Princeton, New Jersey. “These types of accounts are great for introducing kids to the world of investing and teaching them about making money and saving money for long-term goals. Traditional IRAs can offer instant tax breaks if a child files a tax return, and Roth IRAs can offer tax-free growth even without the necessary minimum distributions. “
Many parents enjoy opening bank accounts for their young children as a way to introduce them to the wonderful world of high finance. In fact, banks often offer special “children’s savings accounts” to encourage this.
Children’s IRAs, on the other hand, provide a stronger blow to the goal of teaching their children what they need to learn about money. And unlike traditional bank savings or a current account, they naturally limit early withdrawals. For parents who care about their child’s spending discipline, this might be appealing.
“IRAs for Kids make great savings for teens,” says Jazmin Gabriela Carpenter, vice president, Investments at Wedbush Securities in Los Angeles. “Their youth and the decades ahead of them give them a huge advantage when it comes to investing. It can provide them with valuable financial lessons such as earnings, savings and spending which is an integral part of financial literacy. Let’s not forget the important composition lesson that works best for their age because they have time on their side. Another advantage is that the funds could be used for other important expenses such as education expenses (they will have to pay income tax, but there is no 10% penalty for early withdrawal if the money is used for qualified education expenses such as tuition, books and supplies) or buying a house (they can withdraw funds to be used as an advance or closing costs before they turn 59). You can raise a maximum of $ 10,000.00 for this purpose. These early withdrawals are tax-free. However, it is always recommended that these funds be kept intact, if at all possible. “
So how does a teenager set up an IRA to contribute to that summer’s earnings?
Well, there is bad news for teenagers seeking independence. I can’t do this alone.
“To open an IRA for a child, a parent, guardian, or other adult will need to open an account on behalf of a minor,” says Tiffany Lam-Balfour, an investment and retirement specialist at NerdWallet in San Francisco.
Once you set up this IRA for children, you will have to decide whether it will be a traditional IRA with deferred tax or a Roth IRA after tax. For most teens, one option is a clear winner.
“As for setting up an IRA for a working child, I would recommend Roth to the IRA over a traditional IRA,” says Mike Cocco, a financial expert with Equitable Advisors in Nutley, New Jersey. “Roth IRAs don’t get tax breaks in advance, but that’s okay! Most teenagers or students may have such a low income that they pay little income tax anyway, so a tax deduction can be pointless. However, the Roth IRA grows with tax deferral, so you don’t have to declare dividends and interest on their taxes every year as a normal investment account. They are also non-taxable (even earnings!) If they keep it until the age of 59 … so over decades of savings and investment these gains can be quite substantial and potentially all non-taxable can be accessed. “
No matter what kind of work your teens enjoy this summer, don’t miss (literally) once in a lifetime the opportunity to start building a valuable financial education as well as a good solid base of a fertile and relaxed pension.
“Setting up an IRA helps launch teen retirement accounts, and also helps develop healthy investing habits,” says Nicklas Norrell, a wealth management advisor and chief of staff at Croak Asset Management in Toledo. “I love seeing kids start with young people and calm down with the idea of saving and investing before they start making real money. Using a Roth IRA while young for future high earnings is also an extremely popular strategy. “
And, remember, it’s not too late. Like any other IRA, you don’t have to contribute earnings until next April.