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Retirement is probably not on most teens’ radars, but it should be. That’s because a relatively small investment today can grow into a substantial sum after decades of compounding. A great place to start is with a Roth IRA, which offers tax-free growth and tax-free withdrawals in retirement. Here are a few tips to get your teenager started on planning and saving for their future.
Key Takeaways
- Although most teens don’t think about retirement, it’s important to help them get started early and make saving a habit.
- Setting up a Roth IRA for teenagers can provide them with a comfortable financial future with relatively little effort.
- Anyone with earned income can contribute to a Roth IRA regardless of their age.
- An adult must open a custodial account for a minor and controls the account until the child reaches the age of majority, at which point, the young adult takes over.
Tax-Free Growth and Income for Retirement
One of the biggest perks of a Roth IRA is the tax break it offers. With a Roth IRA, you don’t get an upfront tax break as you do with a traditional IRA. Instead, once your money has been inside the Roth IRA long enough and the account owner is old enough–two requirements that are easily met by the time a teenager is ready to take withdrawals in retirement–you can withdraw money tax-free. In the meantime, your contributions and earnings grow tax-free, and that goes on for as long as you live.
This usually works out well for teens since most teens pay little, if any, income tax. If a teen has a summer job or works during the school year, their pay makes them eligible for a Roth. Here’s how it works:
- Roth IRA contributions aren’t tax deductible, but when the teen gets older, they’ll enter a higher tax bracket yet won’t have to pay any taxes on their Roth IRA’s investment earnings or withdrawals.
- Contributions can be withdrawn anytime, for any reason, without owing any taxes or penalties. However, the account holder will need to hold the account for a minimum of five years and wait until they are at least age 59½ to take out the earnings to avoid a 10% early withdrawal penalty.
You Need Earned Income to Fund a Roth IRA
Anyone can contribute to a Roth IRA, regardless of age, including babies, teenagers, and great-grandparents. Contributors just need to have earned income the year they contribute.
How Much a Teen Can Contribute to a Roth IRA
A Roth IRA contribution can only be as large as the contributor’s earned income. So, if your teen earned $4,000 in 2024, that is the maximum amount they can contribute for that year.
Contributors can kick in an amount up to the annual Roth IRA contribution limit–which is $7,000 for 2024 ($8,000 for contributors who are age 50 or older)–whichever is less.
Types of Earned Income That Qualify
Individuals earn income when they work for someone else who pays them, or when they own a business or farm. While babies are unlikely to have earned income unless they are child models or actors, the type of work teenagers often do—babysitting, lifeguarding, and barista-ing generally qualify. Investment income does not qualify since it’s considered unearned income, and gifts do not qualify either.
A teenager’s pay must be legitimate and at the going market rate. For instance, parents cannot pay their kids $1,000 an hour to mow the lawn and call it earned income. Ideally, the teen will receive a W-2 to substantiate their earnings. Otherwise, it’s a good idea to keep excellent records from odd jobs that do not provide tax records.
Adults Can Contribute to a Teen’s Roth IRA
The Internal Revenue Service (IRS) does not care who contributes to the IRA. The teen just needs enough earned income to equal (or exceed) the contribution.
In other words, parents and other adults can match a teen’s earnings and contribute to the Roth. For example, if your teen earns $3,000 at a summer job, you can make a $3,000 contribution and let your child spend (or save) their money. Or, you could help by contributing a percentage of your teen’s earnings—say, 50%.
How to Open a Roth IRA for a Teen
An adult must open a custodial Roth IRA account for a minor, which is typically age 18 in most states and 19 or 21 in others. These accounts are essentially the same as standard Roth IRAs, but the minimum investment amounts may be lower. Many brokers offer custodial Roth IRA accounts. Firms that currently offer accounts for minors include Charles Schwab, E*Trade, Fidelity, and Vanguard.
As the custodian, the adult controls the assets in the Roth IRA until the minor reaches the age of majority. At that point, the account belongs to the minor. A minor can continue to invest in a Roth IRA and set themselves up for a sound financial future—as far off as that future might seem.
Can Anyone Contribute to a Roth IRA?
A Roth IRA has no age threshold or limit for contributing to an account, but you must have earned income that covers your contributions. However, Roth IRAs have income limits, meaning if your modified adjusted gross income (MAGI) is too high, you may not be able to contribute the full amount or anything at all.
For 2024, if you’re a single tax filer, you can make the full Roth IRA contribution if your MAGI is less than $146,000 and a reduced amount if your MAGI is $146,000 or higher but less than $161,000. The phaseout range for married couples filing together is a MAGI of $230,000 or higher up to but less than $240,000.
What Is the Youngest Age You Can Open a Roth IRA?
There is no age threshold or limit for Roth IRAs, so that anyone can open and fund an account. That means babies can get started on their nest eggs, provided they have enough earned income to cover their contributions.
At that age, earned income generally comes from modeling or acting. Young children can earn income through odd jobs or even working for mom and dad’s business—but the child must do real work, and the parents must pay a reasonable wage.
How Much Could a Roth IRA Grow in 50 Years?
A teenager who starts saving for retirement in a Roth IRA can take advantage of decades of compound interest, setting them up for a very comfortable retirement. Suppose you are 16 years old, and your annual contributions remain at this year’s basic limit of $7,000 through age 65, and your Roth IRA averages annual returns of 7% during that period. For the sake of keeping this hypothetical example simple, let’s say you never shift to larger annual contributions despite the availability of catch-up contributions. By age 65, your Roth IRA nest egg would be worth $3.04 million.
If the account does better—say, an 8% annual rate of return—it would be worth $4.33 million by the time you reach age 65. In both examples, you would contribute a total of $350,000 over five decades.
The Bottom Line
If everyone started a Roth IRA for their kids, there’s a good chance more people would be financially prepared for retirement. For example, a single $7,000 contribution made at age 16 could grow to more than $552,000 over 50 years, assuming an 8% annual rate of return. By starting early, you help set your child up for financial success by establishing healthy saving habits and jumpstarting their nest egg.
Retirement Security Rule: What It Is and What It Means for Investors
At some point during the decades when you or your teenager-turned-adult nurtures their Roth IRA, you or they might seek investment guidance from a financial advisor. In that situation, you or your offspring should know about the Retirement Security Rule. Also known as the fiduciary rule, the new regulation’s purpose is to protect investors from conflicts of interest when receiving investment advice that the investor uses for retirement savings.
The rule was issued by the U.S. Department of Labor (DOL) on April 23, 2024. It takes effect on September 23, 2024. However, a one-year transition period will delay the effective date of certain conditions to 2025.
If an advisor is acting as a fiduciary under the Employee Retirement Income Security Act (ERISA), they are subject to the higher standard–the fiduciary best-advice standard rather than the lower, merely suitable advice standard. Their designation can limit products and services they are allowed to sell to clients who are saving for retirement.