How can the Teens build up wealth and eliminate future tax risk at the same time?
Answer: a Teen-Ager should consider a Roth IRA account and you can help them! Let’s discuss why you might want to do this and some benefits.
However, let’s get some facts straight on Roths before making the case for why your teen-ager should consider a Roth:
1. A Roth IRA is a tax shelter, it is not an “account” in and of itself. I like to think of it like a bowl. The Roth is the bowl and just as you can put many types of fruit in a fruit bowl, you can put many types of investments into a Roth “bowl.” For example:
- Mutual funds
- Savings Account
- Real Estate
These are just some of the examples of investments that can constitute your Roth IRA. The Roth itself is merely a tax law that “surrounds” your chosen investment and makes it a tax-favored account.
2. What does a Roth IRA allow?
It allows an investor to place up to $5,000 per year, or 100% of earned income (whichever is less) into an account where the earnings and gains will grow tax-free and be available tax free for retirement. There are of course, stipulations and rules, which you should review with your investment advisor and/or tax professional; however, let me cover a few of them:
a. there is no current year tax deduction for contributions (like with your 401k). That’s the trade off for tax-free later (you have to pay taxes when you withdraw from your 401k at retirement).
b. you can withdraw funds at age 59 1/2 typically (there are exceptions). Earlier than that might expose you to penalties.
c. You can access Roth IRA funds for college expenses, and first time home purchases but the tax rules change a bit (again, consult a pro).
d. there are other rules to know (which you should consult a pro on) but for now, let’s get to why your kids should consider this.
Why Your Teen-Ager Should Consider A Roth – Bottom Line:
1. one, the younger generations more than any other, will be on their own – fewer pensions, social security might get pushed to later ages, etc
2. the money in a Roth can be accessible in some circumstances (flexibility for life changes).
3. Money could compound more powerfully with time than it does with rate of return. Let’s compare saving $25/week starting at 16 vs starting at age 30. We’ll give the 16 yr old a 6% rate of return and the 30 yr old a 9% rate of return and take each to age 60. What’s the final balance?
16 yr old balance at age 60 growing at 6% per annum: ~$281,149
30 yr old balance at age 60 growing at 9% per annum: ~ $199,983
TIME MAKES A BIG DIFFERENCE!
4. you can teach your teen how to be responsible for themselves and not be financially dependent.
5. you can make the contribution as long as the teen as EARNED INCOME! if the teen earns $50/wk but needs the money for expenses, you as the parent, grandparent etc can give them the money to contribute because they have earned income. It does not have to be their actual money. if the teen does not earn income (i.e. W2 or 1099) then they can not fund a Roth IRA, even with gifted money.
These are 5 solid reasons your teen-ager should consider a Roth IRA. not bad reasons eh? What do you think? And remember to consult a pro before doing this just to dot those “i’s” and cross those “t’s.”
Considering Roth IRAs and other smart ideas for your family? Work with someone who thinks of 3-4 generations when planning money. Find out more HERE.
Feature image credit: Steve Jurvetson