Can Teens Invest Their Summer Job Earnings in a Roth IRA?

Landing a summer job is an exciting milestone for any teenager, and receiving that first paycheck is even more gratifying. While the temptation to splurge on the latest trends with this money may be strong -- at least that was the case back in my day -- teens might be better off considering their future financial security.

Setting aside part of their earnings in a Roth IRA, for example, can teach valuable lessons about saving and investing, potentially setting them on a path to a millionaire retirement . If you're looking to give your teen a leg up in life, introducing them to the benefits of a Roth IRA could be the perfect gift.

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Getting started

Stashing away money in a Roth IRA might be a great option for young earners, because contributions are made with after-tax dollars while a teen is likely to be in a lower tax bracket. That means they pay taxes now at a lower rate, and in turn, they can enjoy tax-free income during retirement when their tax rate might be higher.

So if your child or another teenager you know is earning money this summer, here are a few things to consider to help them get started.

• Do your research : Understand how a Roth IRA works to maximize its benefits and determine if it's a good option for your teenager. Consider consulting with a certified financial professional for guidance.

• Review the requirements : Make sure your teenager has earned income for the year. Earned income includes money from a paid summer internship or another W-2 job, as well as activities like shoveling snow, modeling, or babysitting. Keep detailed records of the teen's income, including the type of work, dates, hours worked, employer, and payment amounts. It's best to consult with a Certified Public Accountant to ensure you aren't missing anything for tax purposes.

• Open an account : A parent, family member, or another adult can open a custodial Roth IRA and manage the account on behalf of a teenager until they the teen is legally able to do so on his or her own. Be prepared to provide the teen's personal information, such as name, Social Security number, and birth date, when setting up the account.

The 411 on Roth IRA contributions

In 2024, the maximum contribution to a custodial Roth IRA is $7,000 as long as your teen doesn't exceed the income limits . However, if your teenager earns only $4,000 from a summer internship and has no other income for the year, the contribution limit is capped at $4,000, since Roth IRA contributions cannot exceed the earned income for the year. You can help your child contribute the maximum amount by offering to match contributions.

For example, if your teenager earns $4,000 in 2024, he or she could contribute $2,000, and you could match this amount to maximize your teen's contributions for the year. Contributing $2,000 directly from your teen's paycheck might seem daunting, so demonstrate how he or she can set aside a manageable amount weekly or monthly to reach a goal by the tax filing deadline, typically April 15 of the following year.

Show your child how investing works

While saving money might not initially excite teenagers, showing them how they can invest their funds and grow their wealth could keep them motivated on this financial journey. This is an ideal opportunity to demonstrate how the math they've learned in school can be applied to calculate the potential earnings from their investments.

For example, let's say you and your child set aside $7,000 in a Roth IRA every year, and your teen continues those contributions even when he or she controls the account. Show your teen the historical averages for certain investments, and then demonstrate how to calculate the potential growth of money at various rates of return, such as 7% or 8%. Following is an example of how $7,000 invested annually could grow with an average return of 8% and 10%. It's important to note that returns aren't guaranteed.

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Although your teen may have just started working and might not be thinking about retirement yet, contributing to a Roth IRA can teach valuable financial lessons. Exposing your teen to saving and investing early can help him or her better manage money in the future. Teens can also become better decision-makers because researching investments requires them to assess their options and choose the best ones that align with their goals. By helping your teenager open a Roth IRA with that first paycheck, with commitment and patience, he or she will be well on the way to a comfortable retirement.

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