Teens with summer jobs might already be saving for cars and college costs, but financial experts say they should also consider putting money aside for a retirement that’s a half-century away.
Young workers are likely more focused on leaving the nest than starting a nest egg, but the following scenario from The New York Times illustrates the advantages of investing early.
Let’s say your teen takes $5,000 in savings from a few summer jobs and puts it in a Roth Individual Retirement Account at age 19. It will climb to $52,006 by the time she is 67, if it grows at a modest five percent annual rate. If she waits until she’s 25 to start with that same $5,000, the balance at age 67 is just $38,808.
And the interest compounds even earlier for teens who invest in a custodial Roth IRA. Parents can co-sign for an IRA and young people can begin investing as soon as they start earning income.
“The beauty of the custodial Roth IRAs, for those that can make the long-term commitment of investing until retirement, is that Roth IRA earnings grow tax-free,” says Michele Clark, of Clark Hourly Financial Planning and Investment Management in Chesterfield. “And for most minors, but not all, the contributions that go into the custodial Roth IRA aren’t taxed because the minor is in the zero percent tax bracket. But the most important advantage to a custodial Roth IRA is the wonderful magic of time growing those assets!”
And it’s practical magic that can eventually make teens millionaires. If that 19-year-old in the previous example starts with $5,000 and makes the maximum contribution – currently $5,500 – each year until age 67, the ending balance is $1,164,985 if the account grows at five percent annually. That’s better than $330,000 more than what someone would end up with if they waited just six years, until age 25, to start a Roth and then saved the same amount until age 67.
Just like a regular Roth IRA, younger investors with custodial IRAs can set aside up to $5,500 a year, or 100 percent of what they earn, whichever is less. Parents and other adults can also contribute to a young person’s Roth IRA although they will likely be in a higher tax bracket than their teens, and will probably have to pay income taxes on contributions. No matter who’s making the deposits, Clark points out total annual contributions are currently capped at $5,500, or 100 percent of what the teen earns. She also advises that parents and teens should investigate the impact any investments might have on college financial aid.
“I have had clients who told me that they offered to match their kid’s contributions to the custodial IRA. So if the kids put $500 in the parents match $500,” she says. “This establishes a nice habit of saving for their own retirement and it mimics the type of saving they will see in an employer retirement plan.”
It also teaches young people the value of diversification. While some parents consider investing in individual stocks from their kids’ favorite companies as a way to get them interested in investing, putting money into an IRA or other investment vehicle that includes a varied portfolio is a better bet, says Clark.
“One danger to avoid is the temptation to pick one stock to invest in thinking that you want your child to see that company, perhaps a favorite manufacturer or restaurant, and know that they are an owner of that company. That well intentioned lesson can seriously backfire when you put all your eggs in that one basket.”
In contrast, starting early and spreading the wealth can keep a nest egg safe and might make your hardworking teen a millionaire by the time he’s ready to retire.
Charlene Oldham is a writer and teacher. She lives in Crestwood.
