Your teenager just got a job and will soon be getting that first paycheck. Or maybe she's earning extra cash by babysitting or walking dogs. Although visions of video games or a shiny new car might be dancing in your youngster's head, it's wise to consider stashing that cash for the long haul.
If you've first set an example by fully funding your own retirement and your teen's college savings, a great way to help your child get ahead financially is to have her open a Roth individual retirement account, or IRA.
Start saving early, reap the rewards
Anyone who has earned income can open a Roth IRA; there's no minimum age requirement. Some financial institutions require parents to open a custodial account for a minor child, but the contributions to it would come from the child's earnings.
Like anyone with a Roth account, contributions would come from after-tax income, if your kid makes enough to owe taxes. There's no upfront tax deduction from those contributions.
Because of the beauty of compounding, where the returns you earn on your saved cash also earn interest, your child could maximize the benefits of saving for retirement by starting early. The longer money earns a return, the more it will grow. The money in a Roth IRA can grow tax-free for decades until your kid is ready for retirement, and at that point, withdrawals from a Roth IRA are also tax-free.
Another benefit of a Roth IRA is that the assets aren't counted in financial aid calculations when it's time for your teen to apply to college. This could make putting earned money in a Roth more attractive than placing it in other types of child accounts, such as a Uniform Gifts to Minors Account, where the assets are considered by colleges when deciding financial aid.
Save for more than retirement
A Roth IRA can be used to help with some shorter-term goals, too. Once an account has been open for five years, the account holder can withdraw up to $10,000 to buy a first home without paying an early withdrawal penalty, which is generally income tax on the amount plus an extra 10% before age 59Â½. Your child could also withdraw money to pay for higher education and qualified medical expenses without tax penalties.
But there will also be nothing to stop your child from withdrawing cash for foolish reasons â€” even if it means paying penalties. You'll want to make sure you're teaching your youngster the value of saving so there's no temptation later to tap that hard-earned cash for unnecessary reasons.
The bottom line
Opening a Roth account is a great way for your teen to get a head start on retirement. By helping to set one up, you can show your child how to plan for the future, take advantage of compound interest and come out ahead when it comes to saving money.
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