Roth IRAs can be in your teen's best interest
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Your teen has a part time job and probably plans for new clothes, video games or maybe a car. However, Financial Planner John Vento says a better bet is to get them to think long term -- really long term -- by opening up a Roth IRA.
"Most people think it's a little funny thinking about retirement for a young child but never the less it's never too early to start planning," says Vento.
So why a Roth? For one thing, with a Roth IRA they won't be taxed on any interest their money earns -- we're talking decades of interest. And since the first $5,800 they earn is tax-free, the money they contribute may also be untaxed.
Of course convincing them to put their money away for, say, 50 years may be difficult, there are some numbers that may help. Let's say they contribute $5,000 a year starting at age 14.
"Assuming they earn five percent per year, by the time they reach age 60 they will have accumulated over $885,000," explains Vento.
That gives them a retirement income of $57,000 a year for the next 30 years. Up that rate of return to an optimistic eight percent and by age 60, they'll have $2.2 million.
"So I can't imagine a better lesson to teach young children. You're basically almost guaranteeing them the opportunity of becoming millionaires at least by the time they retire," says Vento.
While there is a penalty for withdrawing from the account before age 59 and a half, Vento says there is an exception: college. While they would have to pay taxes on the interest in that case, the 10 percent IRS penalty for early withdrawal would be waived. And speaking of education, Vento says parents should not only encourage teens to set up a retirement fund, but use it as a teaching tool as well.
"Let them see that statement every month. Let them look at it. Let them take ownership of it. And always put that thought in their head that ultimately down the road, being financially independent is very important," says Vento.