After reading an article in the NYTimes that urged teens to drop their summer job money into a Roth IRA, I thought, why stop there? Why shouldn’t parents set up a Roth IRA retirement account for their young children? Roths must be funded with earned money – so why not put their babysitting money into a dependent Roth IRA and let them enjoy the results of compounded growth over a half century?
Pretty much nobody does this even though it leads to wicked big retirement accounts. The NYTimes story says:
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.
Is it crazy to set up a Roth IRA for kids?
Full disclosure: I am not an accountant, CPA, financial planner, or anything else with a fancy title and degree. This does not constitute financial advice. Consult a professional before you invest.
Call me crazy or call me rich, but you can’t argue with these numbers.
Compound interest: when you put the earnings (or interest) on an account back into the principal, so it earns interest from then on. More on compound interest from Wikipedia.
If you deposit $300 into your child’s Roth IRA at age 7 (say they had a *very* successful lemonade stand!) and compound the interest for 60 years with no additional contributions, your child will end up with $5,603. That assumes a 5% rate of return.
If you wait and let your child start his or her own Roth IRA, say at the ripe age of 25, that same $300 will only have 42 years to grow (at which point your child will be age 67). With less time to grow, your starting $300, with a 5% rate of return, will turn into just $2,328.
In other words, starting early will more than double your child’s account
But it’s more likely that once you establish the account, your child will continue to pour their allowance and pet walking dollars into their Roth IRA. (Just think of all the ways you can incentivize this.) So with the $300 starting at age 7 and compound the interest for 60 years with an additional contribution of $300 per year, your child will end up with $116,982. That assumes a 5% rate of return.
In the scenario where you wait and let your child start his or her own Roth IRA, again at the ripe age of 25, the account will only have 42 years to grow (at which point your child will be age 67). Your starting $300, plus a contribution of $300 per year, will grow to $44,926. That assumes a 5% rate of return. That’s less than half the balance of the account if you start at age 7.
For these calculations I compounded the interest yearly. (In other words, the earned interest is added to the principal once a year.) You can increase your account even faster by compounding interest monthly. I used the compound interest calculatorsh at MoneyChimp.com, but there is no shortage of calculators out there. Here are our favorite debt calculators.
Make your child a millionaire: secure their future
As your child gets older, they will earn more than $300 per year. In their teens, they may well earn thousands of dollars if they work steadily. What if your child doesn’t earn any money? Here’s what Investopedia says to do:
One option is to hire her at home within the family business (self-employed), as a file clerk or marketing assistant, for example. In this scenario, you can benefit twofold by receiving a deduction from business income, and you can make a contribution to your child’s retirement. If you’re not self-employed, you can still hire your child and pay them via W-2 or 1099-MISC income for cleaning the house or doing other odd jobs around the house – just make sure you document everything carefully, and put the pay directly into the Roth IRA. Since the child is working for the parents at home, no child labor laws are in violation.
When your child starts working outside of the home, you can essentially put 100% of their earnings into their Roth and gift them that amount, as long as the gift isn’t more than what they’ve earned. Just make sure to keep detailed records of their earnings for tax purposes.
Remember, too, that at a certain age your child will take over the account and contributions. It may only be 10 or 15 years that you are truly managing the account and the contributions. You’ll be eager to teach your child how it works and how to manage it so that you don’t have to – and he or she will benefit from even more financial education!
So why not put your kids to work early?
My two-and-a-half-year old already craves the responsibility of these chores:
- She brings in the newspaper from the porch each morning.
- She occasionally sorts the clean silverware.
- She watches her baby sister like a hawk lest she chew on a cable or play with the dog’s water bowl. (“No, Cici, no!” is one of her favorite phrases.)
When you take a look at all your children do around the house, I’m guessing there’s quite a lot of “work” that you could pay them for. If your kids are lazy slobs, ask your accountant if you can count playing video games as labor. Some people actually earn a living playing video games – there are real live competitions and championships for some video games! And perhaps your children could tap into the nascent field of making money by letting other people watch you play video games. I’M NOT KIDDING!!! THIS IS A REAL THING!
My mom always discouraged me from working
In high school, when friends were landing jobs in retail and restaurants and offices, my Mom said to me, “Why do you want to work now? You’re going to be working the rest of your life.”
It was easy logic to accept. Yes, I should be enjoying my youth! I DO want to read another book instead of logging minimum wage on the clock and paying taxes. I had a small allowance and it was enough to get me by. I finally started working (aside from occasional babysitting gigs and summer jobs watering plants while a neighbor was on vacation) in my senior year of high school. I was an assistant to a lawyer’s secretary and on the first day of work the lawyer told me he hated his job and only did it because it paid well. I decided to always pursue work that I found rewarding, even if it didn’t make me rich.
My Mom didn’t have extra money to gift me my earnings so I could put 100% of them into a Roth IRA. But I wished she had told me to put a portion of my earnings into a retirement account.
Now the see the payout of starting a Roth IRA in childhood
Starting a Roth IRA for a young child is a bit different than starting your own IRA. Here’s what you need to know:
- It’s called a dependent Roth IRA (because in the eyes of the IRS your child is a dependent)
- Check for one with a low minimum starting deposit (because it’s unlikely your 7-year-old earned $5,000 in one year)
- A child’s retirement account may work against them when it comes time to apply for college financial aid, says Forbes (very last paragraph).
- But you can use the contributions (just not the earnings) to help pay for college without penalty, says Kiplinger.
- You can withdrawal money from your Roth IRA starting at age 59.5 with no taxes or penalties as long as you’ve met the five-year holding requirement. More on the five-year holding requirement.
One big reason NOT to start a Roth IRA for your kid
There is no financial aid for retirement. So if you haven’t saved enough for your own retirement, let your kid fend for herself.