Believe it or not, your kids can be making contributions to an IRA (Individual Retirement Account) at any age – provided they have some income.
The benefits of having an IRA are awesome: investments grow tax-free in these accounts, so they get the full benefit of compound interest without taxes getting in the way. Kids also have the option of tapping into their IRA if needed for college expenses, and can someday take out up to $10,000 to assist in buying their first house.
When opening an IRA for your kid, you’ll be opening a custodial account, called a Guardian IRA. The account is in your child’s name, with her social security number, but you have complete control until she turns 18. Not all investment companies allow Guardian IRA accounts, but many of the big ones do. Schwab, in fact, allows Guardian IRA accounts to be opened with just a $100 starting amount.
Don’t you need a job first?
I used to think that kids needed a “real” job (with a W-2) to contribute to an IRA, but I was wrong. If your 15-year-old daughter is doing babysitting jobs, she can be putting that money into an IRA. As usual, with all things related to the IRS, she’ll have to have careful written records of that income:
- How much was earned
- Date and hours worked
- Type of work, for whom
It shouldn’t be too hard to keep track of this income. If she’s using any kind of budgeting tool like Goodbudget, she can just enter the specifics there. Another handy way to keep records is to send yourself an email with the details, and then put something like “2014 income babysitting” in the subject line. It’ll be easy to find in a search later.
Current IRA rules limit contributions to $5,500, or the amount of earned income, if that’s less. So if she only earns $2,000 for the year in babysitting, this is the maximum annual contribution.
The 401(k) match
Many employers have retirement plans for their employees, including the 401(k) plan. A common feature in 401(k) plans is the “match” – an additional amount the employer puts in, matching some or all of the employee’s contribution. For the employee, it’s a great incentive, and an instant return on investment.
The 401(k) match is something you can do with your kids, as well. There are a couple of ways this might work:
- Whenever your child makes a contribution to her IRA, you make a matching contribution.
- Whenever your child earns income, she gets that money (to spend, share, and save) AND you make a matching contribution to her IRA.
The power of compound interest
It’s easy to see the power of compounding, and the benefits of starting early.
If your daughter gets started at age 15 and contributes (or you help through matching) $2,000 each year through her teenage years, and then continues contributing just $2,000 each year when she moves out, she’ll have between $500,000 and $1,000,0000 at retirement age, depending on investment returns.
If she waits until she’s 25 to start investing in an IRA, the nest egg is cut in half. She could actually contribute $2,000 per year from ages 15-25 and wind up with the same nest egg as if she contributed $2,000 per year from ages 26-65. (Click on the table to see the details)
So… what to do now?
I wish that I had started contributing to an IRA in my teens. Heck, I wish I had started contributing in my 20s. I’m not on the left-hand side of that chart, I’m in the middle playing catch-up. But I want my kids to be on the left-hand side. We can find a way to save $2,000 per year with our kids – and hopefully, as they get older, they’ll continue saving each year, and wind up with the bigger reward on the right.
Don’t hold back – go out an open up an account for your kids today. Even if it’s just with $100. Be ready for your kid’s next payday!