In some families, teenagers contribute to basic costs like housing. In others, parents expect summer earnings to replace a weekly allowance. Many teenagers save for their first car, and few among the college-bound escape the pressure to put money away for tuition.
Some parents dictate the terms, while in other families, there's a negotiation over how to divide the money once a summer job has ended. It's rare, however, that families consider the possibility of giving a child a running start on retirement savings.
It's a shame, too. That's because the boost that comes from opening a retirement savings account as a teenager instead of a few years after college can lead to hundreds of thousands of extra dollars after a half-century of growth.
Most of us have seen basic compound interest graphs before, so we know how the math works for grown-ups who start setting money aside from their first full-time paycheck. But beginning even earlier supercharges the savings for families that can afford it — or who reel in grandparents and others willing to match a child's contributions.
The process starts with a Roth individual retirement account, and it will need to be a custodial account, with an adult cosigning, if the teenager is under 18. The nice thing about Roths is that you generally pay no taxes on the withdrawals. So the money will grow for many decades and then come out tax-free as long as the rules don't change. While there are no tax deductions for deposits, that doesn't mean much to teenagers whose income is so low that they may not pay any income taxes at all.
If you're trying to persuade children or grandchildren to save rather than ordering them to do so, you could start with some simple numbers. If you take $5,000 in savings from a few summer jobs and put it in a Roth at age 19, it will grow to $52,006 by the time you're 67 if it grows at a 5 percent annual rate. Wait until 25 to start with that same $5,000, however, and the balance at age 67 is just $38,808. You can plug your own numbers and investment return assumptions into the Roth IRA calculator at dinkytown.net.
Things get more interesting, however, if you pledge that once a Roth is open, you'll spend a few years helping a young adult max out the $5,500 contribution each year as long as that person earns the $5,500 necessary to make a deposit of that size. If that 19-year-old starts with $5,000 and makes the maximum contribution each year until 67, the ending balance is $1,164,985 if it grows at a 5 percent annual clip. That's over $330,000 more than what someone would end up with if they waited just six years, until age 25, to start the Roth and then saved the same amount.
For grandparents, uncles, aunts and others looking for a way to make a meaningful contribution to a child's future financial stability, this is a nice way to do it while directly rewarding hard work. You might match some or all of what teenagers make and even open the account with them. It's also fine for you to give them the matching funds for the Roth, while all of their actual earnings go toward the car, college or allowance replacement.
