At Back-to-School Time, Consider a Roth IRA for Your Child

As kids across the country head back to school, many are leaving behind their summer jobs. Whether it’s a teenager babysitting or mowing lawns, a high school student working for a painting crew or a moving company, or a college student with a paid internship in a law firm or accounting practice, all have one thing in common … the opportunity to contribute to a Roth IRA.

Roth IRAs are especially appealing to students, since most probably don’t earn enough to pay income tax, and thus would get no tax benefit from making a traditional IRA contribution. For 2017 those individuals with earned incomes below $6,300 and unearned incomes of $1,050 don’t pay any income tax. This covers most students age 21 and under working summer or part-time jobs.

Roth IRAs trade the benefit of a current tax deduction for the advantage of paying no tax when funds are withdrawn, as long as it’s after the account owner reaches age 59½. (Note: There are other permitted Roth withdrawals prior to age 59½: Assuming your Roth has been open for five years, you can withdraw your contributions — but not the investment gains — at any time without paying taxes or a penalty. Please seek advice from a professional adviser for more information.)

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Our firm encourages our clients with children engaged in part-time employment to consider a “match” for Roth IRAs. Doing so helps parents instill good saving habits in their child and is great head start on saving for the child’s retirement. A match for a working child operates similarly to the familiar 401(k) employer match. Here’s how it might work:

Bill’s 15-year-old son, Sam, earned $1,000 over the summer mowing lawns. Bill offers to contribute $2 for every $1 Sam contributes to a Roth IRA. In this example, Sam puts in $300 and his father puts in $600 for a total Roth contribution of $900. Annual Roth IRA contributions are limited to the amount earned, but the funds contributed needn’t come from the account owner. A match is great way to get a child started on the path of financial independence.

Here are a few ideas that may help implement this strategy:

• Don’t be afraid to start small. Even a contribution as low as $250 made annually at a young age can add up.
• Grandparents can get into the act, too. A match can come from either parents or grandparents. Just remember, the total contribution can’t exceed the amount earned by the child, and the annual Roth contribution limit is capped at $5,500.
• Make it a learning opportunity. Use the Roth IRA experience to teach your child about investing for the long term and about the basics of investing and asset allocation.
• Invest for growth. In most cases the child won’t tap into the Roth for 30 years or more. Consider investing in an S&P 500 index fund or other low-cost equity-oriented investment. Many mutual fund families and brokerage firms have reasonable account minimums for IRAs for minors.

Roth IRAs offer a great savings opportunity, and as long as you’re earning an income, you’re never too young to start.