While saving for children's education and setting up an emergency fund is common among parents planning for their kid's future, leveraging the power of a Roth IRA for them often goes unnoticed. This retirement savings account can be an exceptional tool for instilling financial discipline and literacy in teenagers. Even modest, regular contributions from a young age can amass significantly over time, providing them a significant financial advantage.
Roth IRA accounts are powered by after-tax money. Given that most teenagers barely earn enough to qualify for federal income tax or fall in the lowest bracket, the benefit of "pay taxes now, grow tax-free later" generated by Roth IRA can be incredibly lucrative. Teens can contribute to this account from their earnings from part-time jobs, summer work, internships, or self-employment, up to a limit of $7,000, provided the contributions don't surpass their annual earnings.
The long timeframe coupled with minimal initial tax liability makes this one of the smartest financial strategies a parent can implement for their child. Plus, a parent can manage a custodial Roth IRA for their child until they reach adulthood.
As a distinct type of individual retirement account, a Roth IRA allows tax-free contributions and withdrawals during retirement, making it a potent estate planning tool to bequeath assets to heirs tax-free. Withdrawals can start at the age of 59½, but there is no obligation to withdraw.
For minors, a parent or guardian can manage custodial Roth IRAs until the child is grown. These accounts are simple to open, cost-effective, and offer the full benefits of investment accounts. They also offer flexibility as contributions can be withdrawn at any point tax- and penalty-free. There are also exceptions for early withdrawals of earnings without the usual 10% penalty for specific expenses related to first-time home purchase, qualified higher education, or disability.
While it may seem odd to set up a Roth IRA for a teenager, it equips them with a strong foundation for long-term financial success. The benefits of compound growth over time, tax advantages during low-income years, and adaptability for future needs make this an asset well beyond mere retirement savings.