A job is a great opportunity for your soon-to-be adult child to get a glimpse at “real” life and responsibility as well as the benefit of earned income. Now that most children are back to school, let’s have a look at one excellent option for long term saving: Roth IRAs.
While saving that first paycheck for retirement is probably the furthest thing from your child’s mind, it is actually a very opportune time to open a Roth Individual Retirement Account. There is no age restriction. You just need to have reportable earned income. In 2014, you can contribute up to 100% of your child’s reportable earnings not to exceed $5,500 per year. But most important, making contributions early in your child’s life allows for the full power of compounding interest to take effect.
Take a look at the graph below. This illustrates the benefit of starting to save for retirement sooner rather than later. By making annual contributions of $2,500 per year for just 5 years beginning at age 20 while your child is in college or a first job and then letting the investments grow at an assumed 7% annual rate, the long term compounding and tax savings are enormous.
With a Roth IRA, the contribution is made with after tax dollars and there is no deduction as with a traditional IRA. The good news is that your child is likely in a low tax bracket, so the taxes on that paycheck are negligible. The bigger benefit of the Roth IRA is that the investments grow tax free so that at age 59 1/2, there is no tax due on the distributions coming out of the Roth IRA. (In addition, the Roth IRA offers some early distribution flexibility without having to pay penalties.)
While your child may balk at the idea, not to worry. There is also no restriction on who can make the contribution—up to the maximum amount earned by the child. The contributor could be your child, or you, or even grandparents who make the contribution on your child’s behalf. If your child is making some of the contribution, you could even agree to match your child’s contributions as an added incentive, leaving her to spend some of her earnings after working hard all summer.
>Your soon-to-be adult children are at the perfect age to learn about saving and the power of compounding interest. Investing and the Roth IRA are effective tools to do just that.
The chart above is intended for illustrative purposes to demonstrate the effects of compounding and is not intended to reflect the actual performance of any specific investment. Individual experience will likely vary.
Meg Welborn works with individuals, couples and families at GW & Wade, LLC. The information provided above is general in nature and is not intended to represent specific investment or professional advice. Always consult an attorney or tax professional regarding your specific legal or tax situation. No client or prospective client should assume that the above information serves as the receipt of, or a substitute for, personalized individual advice from GW & Wade, LLC, which can only be provided through a formal advisory relationship. Please see the “Contact Us” section of our website, www.gwwade.com, for information on contacting GW & Wade.
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