Summer Jobs and Roth IRAs
As we head into Labor Day Weekend, we thought it was timely to talk about how parents can help their kids understand how summer jobs and investing can have a lasting impact on their future. At Riggs, many of our clients talk to us about helping to fund their child’s education. Of course, that is an essential gift for their future. But rarely do they talk to us about perhaps an even more important gift–their child’s future retirement.
Everyone knows the importance of investing early and how compounding returns can create significant wealth. If we start our kids early in building habits for saving and investing, it will pay dividends in securing their future. And this is where a Roth IRA can be a useful tool.
Roth IRA’s are retirement accounts where you contribute after-tax earned income. While there is no immediate tax benefit, the contributions and earnings grow tax-free, and you can withdraw them tax-free after the age of 59 ½ (assuming the Roth IRA has been established for at least five years). Having a source for tax-free income is an important component of any retirement plan.
As teenagers enter the workforce, their need for tax savings is low because their income is relatively low. Opening and contributing to a Roth IRA in your teenage years and later can give you a long runway to allow your investments to compound. For example, let’s say your teenager finds a summer job working at a restaurant. They earn $2,000 that summer. If the income is a W-2 job, they can contribute 100% of their earned income. If the income is 1099, the contribution limit is reduced by 7.65% (half of the self-employment tax) or $153 so they could contribute $1,847 to the Roth IRA ($2,000 less $153). Now let’s look at the effect of compounding. You help your teenager open a Roth IRA and they deposit $2,000 into their account. They then continue to save $1,000 a year in their Roth IRA for the next 49 years for a total of $51,000 in contributions to the Roth. Compounding at a 6% annual rate of return, the Roth IRA would have a value of $325,792 when they are 65. A small contribution early pays big later because of compounding.
Another reason to start a Roth IRA when you are young is the income limits. If you earn $153,000 or more as a single tax filer or $228,000 as a married couple filing jointly, you are not eligible to contribute to a Roth IRA. This is why it is such a good investment opportunity for young people before they hit their peak earning years.
Now, we all know that it is a rare thing for a teenager to worry about having money in retirement, but this is where parents and grandparents can help them. Perhaps, you offer to match anything they put into their Roth IRA thus instilling in them the habit of saving for the future. Or if your child has their earnings earmarked for a specific expense, you can still help them get started on saving for the future by gifting them money to fund their Roth IRA. While the gifting limit is $17,000 per person in 2023, the maximum contribution to a Roth IRA is 100% of your earnings or $6,500, whichever is less. Remember that funding the Roth IRA is limited to the amount of earned income the person has so if they only earned $2,000 that summer, your gift to fund the Roth IRA would be $2,000.
Starting a Roth IRA account for kids once they start to earn income is an excellent tool for securing your child’s future and one they will come to appreciate as they get older.
Each Summer at Riggs, we are fortunate to have college interns working in the firm. This year one of our interns, Emily Mahler, a Junior at Tulane University, shared with us her story of opening up a Roth IRA when she was a teenager. We thought you would enjoy reading her path to saving and investing.
****
WHY KIDS SHOULD OPEN A ROTH IRA
By: Emily Mahler
So, how did I start my Roth IRA?
Like every young student, I started to think about college when I entered high school. Only four years away, I needed to figure out what I wanted to study and if I had an interest in anything. I always knew I enjoyed math, critical thinking, and analysis work, but how do I apply my talents to my interests?
During my sophomore year of high school, I was watching YouTube when I came across a video discussing “How to Become a Millionaire.” Seeing as my dreams when I was younger were to become a CEO and travel the world, I clicked on the video. First, the YouTuber discussed how he made his first million through investing. By the end of the day, I binge-watched all his financial literacy videos for young people. I was only 15 at the time and had no job, so the thoughts loomed in the back of my mind until I started my first real job at 16 years old as a lifeguard.
After a summer of working, I waited until my parents asked me what I wanted for Christmas. I sat down with my parents and asked if they would help me open a Roth IRA as part of my Christmas present. They agreed to match my earnings from the summer as my present. That winter, my parents reached out to a financial advisor and opened a custodial Roth IRA for me, and they made my first investment. From that year on, I asked them to match my earnings for Christmas.
So, why did I want to open a Roth IRA?
The answer was simple: I wanted to have money when I was older to travel around the world, and I wanted to have financial freedom. Through those YouTube videos, I learned about “Compound Interest.” Essentially, you put your money in and get interest for that year. Then, the following year you earn interest on the contribution and the interest from the previous year.
The second aspect to know about a Roth IRA is the account is a retirement account. You can only access it without penalty when you are 59 years old. For me, starting at 16 means that I will have 43 years of compound interest. If I invested $1200 a year, I would invest $51,600 by 59 years old, but my account (using 6% interest compounding each year) would have about $239,709.
So, why should you invest in a Roth IRA?
The critical aspects of a Roth IRA besides compound interest are the benefits associated with it when you access it at 59 years old.
First, Roth IRAs are tax-free retirement income. When you make a withdrawal, you will owe nothing. You will not owe money on your interest or your principal. Second, if you withdraw money from your Roth IRA before age 59, you will not face a penalty as long as your withdrawal money comes from your contributions, not your earnings. Third, Roth IRAs offer tax-free withdrawals to your heirs. So, your heir can access their inherited Roth IRA without facing taxes.
****
As you can see, Emily has a good start to building a strong financial future!
As we get together for barbecues and parties this holiday weekend, we hope you consider talking with the young people in your life about starting early in building their financial future. On behalf of the team at Riggs, we wish all of our U.S. based clients a safe and happy Labor Day Holiday!