Why Your Children Need Their Own Roth IRA Now

Give Your Kids an Early Start to Retirement Planning

Why Your Children Need Their Own Roth IRA Now
November 25, 2016

By Hank Coleman

When you think of retirement planning, you most likely don't think about investing for your children. But if you aren't thinking about setting up your kids with their own Roth Individual Retirement Account (IRA) before they finish high school, you may be missing a great opportunity for your children to earn millions of dollars for their retirement.

Your children should have their own Roth IRA as soon as they get their first job. As parents, you will probably have to set up the Roth IRA account for them, but it can be well worth your time and effort. It could set your children up for retirement success before they're old enough to vote.

Roth IRA Rates of Return Starting Young

Most people don't start a Roth IRA until they graduate from college and land their first real job with a salary. If you wait to start retirement planning at that point, however, you'll miss a lot of money. So, how much of a difference can you make by starting a Roth IRA at 16 years old versus after graduating from college at age 22? It's an incredible difference – millions of dollars!

If you had invested $5,500 each year for your children from age 16 to 22, they would have a Roth IRA worth over $49,000 at age 22. This example assumes an 8% annual rate of return. If they never added a dime to the account after they graduated from college at the age of 22, they would have $1 million when they retired at 62. If your children continued to invest $5,500 each year after they graduated from age 22 to 62, they would have amassed a retirement nest egg valued at almost $2.5 million in the end.

If your child waits until they are 22 years old to start investing $5,500 per year, they will only amass $1.5 million by the time they retire at 62 years old. Starting early makes a million-dollar difference in retirement funds. The power of compound interest and time are the best things young investors have on their side.

You Must Have an Income to Invest in a Roth IRA

What’s the catch? Your child must have an earned income to contribute to a Roth IRA. It doesn’t have to be the money the kid actually earned going into their IRA, but they must have earned cash legally in order to open and/or contribute to an IRA. Parents, the child, or other relatives can contribute to a teen's Roth IRA as soon as they have their first part-time job.

You may be able to start investing in a Roth IRA for your children even earlier if they earn money babysitting or mowing lawns in your neighborhood. Sadly, there’s no tax break in it for you. Unlike traditional IRAs, Roth IRA contributions are made on an after-tax basis, so there is no current tax benefit. The trade-off is that earnings from these retirement accounts are tax-free when withdrawn in retirement.

How much can be contributed? 100% of the earnings up to $5,500 per year. You should keep written documentation if they don't file a tax return, in case the IRS ever questions you about your children's income levels and Roth IRA contributions.

So, for example, if your child earns $2,500 one summer mowing lawns in the neighborhood, you can only contribute $2,500 to their Roth IRA. If your son or daughter made more than $5,500 in a given year, then you can only contribute the maximum amount of $5,500 to the Roth IRA, just like any other investor.

This wouldn’t hold true if your child earned more than $118,000 in a year. That would make him ineligible, but the good news is that your actress/model/whatever was making in excess of $118,000 in a year!

Most children would not want to contribute 100% of their earnings to a distant retirement. If you don’t want to put up all the money yourself, you could offer your children matching contributions just like an employer's 401(k) retirement plan. For every dollar they invest in a Roth IRA for their retirement, offer to match their savings as an incentive (up to the limit).

Most of us worry about outliving our retirement savings. Don’t you wish that you had started saving and investing for retirement sooner? A Roth IRA can put your young children on the path to retirement success. Now is the time to set your children up for success with their very own Roth IRA as soon as they earn their first paycheck… or babysitting tip.

People with better credit can save more for retirement because they pay less in interest. You can check your credit score and read your credit report for free within minutes by joining MoneyTips.

Photo ©iStockphoto.com/asiseeit

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Daniel | 11.28.16 @ 17:48
With the trend in it being harder and harder to plan out retirement getting your kids started early seems a very wise idea
Chrisitna | 11.28.16 @ 18:52
Interesting! I wish I had known about this when my kids were still in high school!
Zanna | 11.28.16 @ 19:37
We started college saving too late, and it looks like we've started their retirement savings too late as well. I wish I knew where all this money was coming from. We're barely staying above water now. How do we make this work?
Jane | 11.29.16 @ 00:01
It's easier said than done. Finding an extra $100+ a week can be difficult for many parents, especially if they need to do this for more than one child. If it's possible, the child should be taught to save for retirement just they being told they must brush their teeth every day. The goal may be far off and abstract to a child, but if it's started early, they will hopefully continue doing it all their adult lives.
$commenter.renderDisplayableName() | 12.01.20 @ 14:13