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Roth IRAs trade the benefit of a current tax deduction for the advantage of paying no tax when funds are withdrawn, as long as it’s after the account owner reaches age 59½.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.)
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.
Mike Palmer has over 25 years of experience helping successful people make smart decisions about money. He is a graduate of the University of North Carolina at Chapel Hill and is a CERTIFIED FINANCIAL PLANNER™ professional. Mr. Palmer is a member of several professional organizations, including the National Association of Personal Financial Advisors (NAPFA) and past member of the TIAA-CREF Board of Advisors.
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