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July, 2005 Tax Tip

The Amazing Benefits of a Roth IRA for Your Child

Many teenagers have summer or year round jobs while attending school.  If your child is among the working class, there could be a very significant advantage for him or her later on.  All your child needs to do is put up to $4,000 of his earnings in a Roth IRA.  A Roth is preferable to a traditional IRA because the loss of the current tax deduction of a traditional IRA would be more than compensated for when the child takes tax free withdrawals from the Roth IRA many years from now.  Since teenagers are usually in the lowest tax bracket the tax benefit from a current deduction is rather insignificant.

 

A child of any age can contribute to a Roth (or traditional) IRA.  So if your teenage daughter or son earns money by babysitting or doing odd jobs around the neighborhood he or she is a worthy candidate for an IRA contribution.

 

An illustration of the potential of this should get your attention.  Assume your child works while in high school and earns enough to contribute $4,000 to a Roth IRA for just those four years.  At an assumed rate of return of 8% per year, the account would have a value of over $750,000 by the time he or she is 65.  That money would be distributed tax free.

 

The problem, of course, is discipline.  Having had teenagers myself, the thought of them putting their earnings in a retirement account when they can buy clothes or DVDs is almost non-existent. 

It may be time to be creative or use a little psychology.  An example that has proven successful is to offer to match the child’s contribution.  If your child puts in $2,000 perhaps you can offer to put in the other $2,000.  The funding of the account does not have to be from the child’s earnings so long as the combined contribution doesn’t exceed the lower of $4,000 or the child’s earnings.



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