Summer is a great time for young people to get jobs, earn extra cash, and potentially begin building their savings. Many clients want to know: what’s the best long-term solution for savings? Bank accounts can serve a great purpose, but if you want the money to begin making a difference to their future, Wealth Planning recommends opening a Roth IRA. Here are some important things to keep in mind regarding Roth IRAs, and insights as to why our team thinks they are a great solution for early investments.
Anyone with Earned Income is Eligible to Contribute to a Roth.
Income takes on a lot of forms for young people, but any legitimate pay–including for jobs such as yardwork, lawn mowing, and babysitting–qualifies for investment. In addition, W-2 income qualifies, so if summer means a young person is moving back home and has extra income available, that money can also be invested. The only limitation is that for people younger than 50 years of age, the contribution limits are $6,000 annually (in 2022).
Anyone Can Contribute to Roth IRAs
Parents, grandparents, and other family members can contribute to a young person’s Roth IRA. Wealth Planning Corporation has long advocated that our clients match their children’s and/or grandchildren’s contributions to get as much money as possible into their accounts early on.
Remember: you can match up to the amount of earned income that year or the maximum contribution limit, whichever is less. If your daughter or son makes $1,500 mowing grass, they can put away $500, you match another $500, and Grandma matches $500. Now you’ve put away as much as allowed, and your young person is well on their way. If you repeat this for five summers, assuming 7% return, now the account is around $11,000 as they begin college.
To ensure responsibility of the account, parents can serve as custodians until child becomes of majority age. This is often 18, 19 or 21, but it depends on each state. In Ohio, majority age is 18.
Contributions Grow Tax Free
As long as rules are followed, contributions and earnings grow forever tax-free. It’s ideal to hold the account a minimum of 5 years, and to wait until age 59 1/2 to take out the earnings to avoid a 10% penalty.
Decades of Compounding Interest are in Your Favor
A single contribution of $6,000 made at age 15 will grow to $281,000 over 50 years assuming 8% annual return. This is more than the average 60 year old has saved for retirement according to national statistics. If someone were to make the maximum contribution of $6,000 annually until age 50, the account could grow to $2 million after 50 years assuming 7% annual return.
In summary, the next generation of professionals and families will be far better off if they begin their savings and investment early. Setting them up now will help them be financially prepared for their golden years.