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Why your kid needs a Roth IRA

Making modest contributions during a child's teenage years can add up to a good amount by retirement. It's also tax-smart.

By MSN Money Partner Oct 18, 2012 10:29AM

This post comes from Bill Bischoff at partner site SmartMoney.


SmartMoney logoWorking at a tender age is an American tradition. I'm sure lots of kids did just that over the summer, and some are still doing it after school and on weekends. What isn't so traditional is the notion of kids contributing to their own Roth IRAs. It should be a tradition, because it's such a good idea. Here's the scoop.


Image: Father and son (© Bill Cannon/Photodisc Red/Getty Images)Roth contribution basics

All that's required to make a Roth contribution is having some earned income for the year. Age is completely irrelevant. So if your child earns some cash from a summer job, or part-time work after school -- or whatever really -- the kid is entitled to make a Roth contribution. For the 2012 tax year, your child can contribute the lesser of: (1) earned income or (2) $5,000. These contribution limits apply equally to Roth IRAs and traditional IRAs, but the Roth alternative is the way kids should go in most cases -- for reasons I'll explain.


How much retirement-age money are we talking about?

By making Roth contributions for just a few years during his or her teenage years, your child can potentially accumulate a good sum of money by retirement age. (I know you don't want to think about your baby with gray hair, but it will happen.)


Realistically, most kids won't be willing to contribute the $5,000 maximum to a Roth IRA, even if they have enough earnings to do so. Try talking your teen into saving everything he or she makes instead of spending it at the mall and online. Good luck! Be satisfied if you can persuade the kid to contribute at least a meaningful amount each year. Here's what could happen.

  • Say your 15-year-old pays $1,000 into a Roth IRA each year for three years, starting this year. After 45 years (when your gray-haired "kid" is 60) the account would be worth more than $25,000 -- assuming a 5% annual rate of return. If you assume a more optimistic 8% return, the account would be worth just under $89,000.
  • Say your child contributes $1,500 for each of the three years. With a 5% annual rate of return, the Roth account would be worth about $38,000 in 45 years. At 8%, it would be worth about $132,000.
  • If your kid contributes $2,500 for each of the three years, with a 5% return the Roth account would be worth about $64,000 in 45 years. At 8%, the number jumps to a whopping $222,000.

You get the idea. These are not trivial sums, even though the yearly contributions are modest.

Roth IRAs are usually better for kids than traditional IRAs

For a kid, contributing to a Roth IRA is usually a much better idea than contributing to a traditional IRA for several reasons.


First, your child can later withdraw all or part of the Roth contributions -- without any federal income tax or penalty -- to pay for college or for any other reason. (Roth earnings generally cannot be withdrawn federal income tax-free before age 59½.)


Even though Roth contributions can be withdrawn without any federal tax hit, the best strategy is to leave as much of the account balance as possible untouched until retirement age. That way, your child could accumulate the amounts mentioned earlier and never owe any federal income tax on those amounts. But if money must be withdrawn from a Roth IRA, it can be done tax-free up to the cumulative amount of contributions. Flexibility is a good thing.


In contrast, if your child contributes to a traditional deductible IRA, any subsequent withdrawals will be taxed. Even worse, payouts before age 59 will be hit with a 10% penalty tax, unless the money is used for certain IRS-approved reasons (one of which is to pay college costs, thankfully).


What about tax deductions for IRA contributions? Good question. Your child won't get any for Roth pay-ins, but the kid probably wouldn't get any meaningful tax deduction for contributing to a traditional IRA either. That's because an unmarried dependent child's standard deduction will shelter up to $5,950 of earned income (for 2012) from federal income tax. Any additional income will be taxed at low rates.


So unless your child has enough income to owe a significant amount of tax (pretty unlikely), the theoretical advantage of being able to deduct traditional IRA contributions is mostly or entirely worthless to your child. Since that's the only advantage a traditional IRA has over a Roth IRA, the Roth option is almost always the best option.


The last word

Encouraging your working kid to make Roth IRA contributions is a great way to introduce the ideas of saving and investing for the future. Plus there are tax advantages. It's never too soon for your child to learn about taxes and how to legally minimize them. After all, it's basically a game, and kids love games.


More on SmartMoney/MarketWatch and MSN Money:


Oct 19, 2012 11:43AM
That counts on the Federal government not changing the rules to the game over the course of 50 years until the teen hits 65. FAT CHANCE!!! There are Democrats right now that want to STEAL all of the money in 401ks and IRAs and "save it" for the American people. Yeah, as if the Federal government can do better than me. I still invest in a 401k and I have an IRA but I will take that money out and pay the penalty before I let those idiots steal it.
Oct 18, 2012 7:36PM
As long as its not pludered by Wall Street thieves.

Are we going to be aroud in 2055? Think again!!!!

Feb 5, 2013 5:31PM
I'm calling B.S on this. I've had a Roth IRA since I was fifteen (which was fifteen years ago); I stopped contributing about ten years ago when I realized that I was losing money. The account is still worth less than what's been dumped into it.
Oct 18, 2012 8:30PM

Banking and saving, banks and finacial instutions, have been a fraud committed upon the American child. The American child should be taught the history of all the ways bankers and the criminal American financial system have skinned a cat -- the myth of "Social Security," money creation, fractional lending, the FED, the principal and interest of mortgages, debt. The great frauds. You cannot truly be an American without knowing what you are up against. 

First, it was the tradition of opening a savings account at a bank. That never worked. Worse was how the law of compounding interest became a lie that was never admitted to. One would never tell your children that they were being exploited by a bank, who was making your child's money work harder for the bank then it was for them. What? An American Instittution a lie? A Cheat?

Then it was the phony pension, the 401k. That worked out just great didn't it. Most people lost big in the cra**** been 5-years and the market still has not returned to where it was before the crash. And once it gets there it will be another 15-years before the exploitee gets back to where they were before the crash. Even then, the managers of the 401K will retire on your money sooner than you will.

Now the same crooks that were responsible for preventing, creating, causing, and reporting on the greatest financial collapse since the Great Depression (since none of them were ever proseceuted for criminally defrauding Americans) are back at it. This Roth IRA is just another way for these people to get at you money.


I think people in the financial industry should be arrested for corrupting our young with this nonsense.

Oct 18, 2012 8:44PM
As long as it's not plundered by Barry Obama - wait, he only has until 1.20.13.  Your kids may still have a fighting chance.
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