Many people assume that you should start saving for retirement when you begin your career. While that is true for some, it does not have to be that way for everyone. Your kids can start saving for retirement at a very young age. In fact, there is no age restriction to start contributing to your Roth IRA. You may be asking yourself what a Roth IRA is. It is an individual retirement account where you pay taxes when you contribute to the account. It is considered after-tax money. It’s important to remember that your child must have some sort of income to contribute to their Roth IRA.
Let’s say your child adds money to their Roth IRA, they do not receive tax breaks initially. The tax benefits do go into effect once they are 59 ½ years old. Once they reach 59 1/2 and have held the IRA for five years their withdrawals will be tax-free. If for whatever reason the child needs to withdraw from their account earlier, their contributions will always be tax-free.
A Roth IRA is beneficial to children for several reasons. One of the main benefits is they have several decades for their contributions to increase, while all being tax-free. This leads to something called compound interest. Compound interest is simply interest that is earned on previous interest from the principal amount that continues to accumulate. This is all possible due to the principal amount being reinvested in the stock market to grow the account exponentially. If you are curious about how much you will make there is a simple rule to follow, the rule of 72.
The rule of 72 determines how long it will take for your invested money to double. All you must do is follow a simple formula to figure out when your money will be doubled. You simply divide 72 by the return rate for a specific amount of time. For instance, if you invest in an equity model and the return rate for the year for that model is 10%, you take 72 divided by 10. From that formula, you get 7.2 so it will take approximately 7.2 years for your initial investment to double if all are held the same. This is subject to change due to the market changing but is a good general guideline to follow.
One question you may ask yourself is how your child can contribute to their Roth IRA if they do not have a traditional job? As stated before, your child can contribute to their Roth IRA at any age, but they must have an income of some sort. Many young children are given simple jobs by their parents such as filing papers or cleaning which can be considered an earned income. It is important to keep track of the child’s income especially if they are earning money from mowing lawns or babysitting. This way it is all recorded and can be taxed correctly. Parents can also help contribute to their child’s Roth IRA. Parents are allowed to match their child’s contributed amount if the total contribution does not exceed the child’s total earnings. The maximum amount someone can contribute to their Roth IRA is $6,000 as of 2022.
Having your children save for their retirement early on is great for many different reasons. It not only helps them learn about money management and develop positive financial behaviors, but it also allows them to get the most out of their Roth IRA due to the amount of time it must appreciate. Starting to save for retirement at a young age will be very beneficial and your kids will thank you later in life for having them contribute to their Roth IRA early on.
Any opinions are those of Snow Financial Group and not necessarily those of Raymond James. This material is being provided for informational purposes only and is not a complete description, nor is it a recommendation. There is no guarantee that these statements, opinions, or forecasts provided herein will prove to be correct. Investing involves risk and you may incur a profit or a loss regardless of the strategy selected. Earnings from a Roth IRA withdrawn prior to 59 1/2 would be subject to income taxes.