If you're aiming to set your child up for a comfortable future, opening a Roth IRA might be a great place to start. A Roth IRA is an individual retirement account that allows savers to contribute after-tax dollars in exchange for tax-free growth and withdrawals in retirement. This account type is particularly appealing for kids because it doesn't come with age restrictions, and children are often in a much lower tax bracket when they first start earning money than they will be later.
So if your child landed a summer job this year, here's how that paycheck can put them on a path toward a million-dollar Roth IRA.
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How to start your child's Roth IRA journey
Let's say your child is 16 years old and landed a paid summer internship. You, a family member, or another adult can research the best custodial Roth IRAs, open an account at a financial institution, and manage the account until the child is eligible to take control (age 18 in most states). However, here are a few things to consider before stashing money in a Roth IRA:
- Your child can only contribute to the account during the years when they have earned income from a job or self-employment activities.
- If your child's income exceeds the limits, they won't be able to make direct contributions to a Roth IRA for that year.
- Keep good records so that you can prove your child's income if needed.
- Work with a Certified Public Accountant or other professional to ensure you're following the rules.
Start contributing money to your child's Roth IRA
You can contribute up to 100% of your child's earned income to a Roth IRA, with a maximum of $7,000 for 2024. If your child only earned $5,000 from their summer job and no other income during the year, the total contribution to their account is capped at $5,000 for the year. Keep in mind that allowance, dividends, and interest income do not count as earned income.
You can incentivize your child to contribute some of their earnings into a Roth IRA by offering to match some of their contributions. For instance, using the example above, they could contribute $2,500, and you could contribute the remaining $2,500 to help them max out their Roth IRA for the year. This might be a steep savings rate for a child, so start them off with budgeting. Show them how to track their monthly expenses so they can determine if the way they are using their money will get them closer to the life they want.
Put your child's paycheck to work
Teaching your child good savings habits will help them meet their annual contribution goals, but teaching them how to invest will take their goals to the next level. Depending on where you open their Roth IRA, they can invest in various assets, including individual stocks and exchange-traded funds. Educate your child on the importance of diversification and long-term investing. Show them how different assets work and how to research performance, and instill the discipline to stay committed to their investment plan through market fluctuations. It's also important to let them know about risk and the possibility of their portfolio fluctuating in value.
One practical way to get your child excited about investing is to show them the power of compounding. Teach them how to calculate how their portfolio can grow over time if they invest a certain amount of money and receive a certain average return. Below is an example of how annual contributions of $7,000 could grow over time at 7%, 8%, 9%, and 10% returns, which are in line with historical averages.
|
$7,000 Invested Annually For: |
Growing at 7% |
Growing at 8% |
Growing at 9% |
Growing at 10% |
|---|---|---|---|---|
|
10 years |
$103,485 |
$109,518 |
$115,922 |
$122,718 |
|
20 years |
$307,056 |
$345,960 |
$390,352 |
$441,017 |
|
30 years |
$707,511 |
$856,421 |
$1,040,027 |
$1,266,604 |
|
40 years |
$1,495,267 |
$1,958,467 |
$2,578,043 |
$3,407,963 |
Data source: Author calculations.
The key to helping your child turn their paycheck into a million-dollar Roth IRA is consistency. Get them involved in the Roth IRA contribution process from the start so they understand the power of saving and investing. Although you and your child are not required to make contributions to the account every year, show them the difference between consistent contributions and sporadic ones. The more your child understands the value of time and how the Roth IRA works, the more excited they will be to allocate a portion of their paycheck toward building their million-dollar retirement portfolio.
