OCEAN CITY — At age 16, it’s hard to see past college (or even the weekend), much less into retirement. But parents and grandparents tend to take a longer view, and helping your teens set up and fund Roth IRAs could potentially provide benefits in that far-distant time when their working days are through.
The tax-deferred compounding and flexibility that make a Roth IRA a powerful savings tool for adults can be even more compelling for someone 50 years from retirement. These specialized accounts also create unique teaching opportunities that can help your children get an early start on becoming savvy and sophisticated investors.
This could also be a good time to introduce your teens to the realities of taxes (and tax deductions). Teenagers may initially be put off when you explain that, unlike contributions to a traditional IRA, money going into a Roth can’t get deducted from a person’s taxes. They’re likely to brighten, however, when you point out that workers who earn less than $5,700 a year don’t have to pay income taxes. A teen with a $10-an-hour job could funnel all of his or her savings from the next few summers into a Roth IRA and, decades from now, potentially withdraw a few hundred thousand dollars without ever having to pay federal income taxes on any of it.
Of course, investments can also lose value and a Roth IRA can be an effective vehicle for teaching teens other investment basics, such as the importance of diversification, sound fundamentals and the trade-offs between risk and return. It’s recommended that parents sit down with their kids to research and select the investments together.
To establish a Roth IRA, teenagers will first have to file a W-2 or a W-4 and a tax return with the IRS to help prove they earned the income and contributed it to the Roth. Parents and grandparents are, however, allowed to match those earnings dollar for dollar, provided they’re kept outside an IRA. Initially, the Roth will need to be set up as a custodial account. When your child reaches the age of maturity — 18 or 21, depending on your state — he or she will then assume control of the money.
By that time, though, hopefully your young investors will have a solid appreciation of the benefits of saving.
(A Merrill Lynch Wealth Management Advisor. She can be reached at 410-213-8520.)