One of the first things you probably learned about individual retirement accounts (and perhaps investing in general) is the value of time. The longer you give your investments to grow, the greater your account value will be. This is particularly true in the case of tax advantaged accounts such as IRAs.
IRA for children: the problem. Unfortunately, many individuals wait longer than necessary before they set up their first IRA. When someone waits until they’re age 25 or 30 (or even later) they’re missing out on a decade (or more) of growth opportunity. The good news is that there is no minimum age requirement for opening an IRA. The only requirement is that the account owner have at least as much earned income as they seek to contribute in any tax year, so we can help our children start their own IRAs if they have earned income.
IRA for Children tip #1: The Lasting Importance of a Summer Job. A teenager’s first summer job can be extremely important to developing their character and strengthening their work ethic. And, of course, having the ability to earn their own spending money – and make the connection between working hard and being able to enjoy the fruits of that labor – is an invaluable lesson.
But take a minute to think about the benefits of starting an IRA with some of that money. A 15 year old who opens a new IRA with just $1,000 of their summer earnings can expect for that single, relatively small contribution to grow to nearly $50,000 by the time they’re ready to retire (assuming an 8% annual rate of return).
IRA for Children tip #2: Which Dollars to Contribute to the IRA. Keep in mind that an individual only needs to have earned income during the same tax year that they want to contribute. The dollars they earned don’t need to be the exact same dollars that go into the account. So, for example, if your teenager earns $1,500 next summer then they’re eligible to open a new account (or contribute to an existing account if they previously set one up) and contribute $1,500. Their contribution can actually consist of their own money, plus money that you provide, so long as the total is not more than their earned income for the year).
IRA for Children tip #3: Consider the Roth IRA. Because your child is likely not to have a significant tax bill based on their summer earnings, the immediate tax deductible nature of a traditional IRA is going to be largely (or entirely) inapplicable. In general, a Roth IRA will be the preferred structure for a teenager opening an account.
IRA for Children tip #4: Explaining Options. If the concept of an IRA or the long term timeframe is a bit too difficult to explain to your child, you can explain how they could take penalty free distributions from their accounts for various reasons, including paying college expenses or for up to $10,000 for a down payment on a first home.
You can’t simply set up an individual retirement account on behalf your children – the rules governing IRAs very clearly prohibit this. They need to be the account holder, and meet the earned income requirements themselves. But that doesn’t mean you can’t help them get their own accounts started. They may not understand exactly why it’s so important to do so, but they’ll certainly thank you when they’re older.
Quest Trust Company helps change people’s lives and financial future through self-directed IRA investment education. Quest Trust Company helps people invest in what they know best and build their financial future on their own terms.