Wise parents find time to teach their children about personal finances while they are still young. As soon as your child is old enough to have even a summer job, they are eligible to fund a Roth IRA. In the end, early investing can make all the difference for them as adults. In this article, Dan Calugar, an experienced investor, takes a look at five reasons every young person with earned income should open and fund a Roth IRA.
Because a Roth IRA is funded with post-tax money, that is to say; you’ve already paid the required tax on the money you put into the account, it offers some significant tax advantages. These include tax-free growth on your investment and tax-free withdrawal of the fund when you retire.
As of 2020, young people can invest up to $6,000 of earned income each year. If your child begins funding a Roth IRA as a teenager or young adult — and they consistently continue to invest throughout their working years — retirement should be a breeze. They may not recognize now how important that will be to them in the future, but that’s why they have you as a parent — to teach them.
- Starting early means more growth: The longer your child’s money is invested, the more it will grow. Most workers contribute to an IRA for 25 to 30 years, at best. If your child begins in their late teens, they will be faced with the happy options of choosing between early retirement or an even more comfortable one.
- Take advantage of a lower tax bracket: Because contributions to a Roth IRA are taxed as the money is earned, being in a low tax bracket is beneficial. There are no tax breaks for putting money in the account, but children are not likely to be looking for tax deductions early on.
- Lenient withdrawal rules: Contributions to a Roth IRA can be withdrawn at any time. After your child has contributed for five years, they can take out up to $10,000 in earnings to buy a first home. There are other qualified expenses, such as college tuition, for which earnings can be distributed without penalty.
- Earn more than a savings account: Young adults are naturally attracted to the liquidity of a savings account. They may not have the financial discipline to recognize the advantages of the long game. A simple lesson to demonstrate the difference between a 1% interest rate and a 6% interest rate over 50 years should be proof enough.
- Tax-free withdrawals: By every estimation, tax rates will be higher when your child retires than when they begin their career. Making contributions at a lower tax rate coupled with tax-free withdrawals at retirement make the Roth IRA well suited for young investors.
Roth IRAs are purpose-built for the long-term investor that begins early. With even far less than the maximum allowable contribution, your teenaged child can set themselves on a course that will provide significant benefits throughout their lives.