Should your teenager start to save money for retirement?
It’s official, my baby sister just got her first job at 17! (I know, we’ve got a large age gap.)
And being the personal finance-obsessed big sister that I am, the first thing I said was “let’s get you an IRA!”
Saving for retirement while still in high school? Is that even possible?
Yes, it totally is!
Why Should A Teenager Save Money For Retirement?
Retirement is practically a lifetime away for a teen. But because of the magic of compound interest and low tax bills, the teen years are the best time to begin saving for retirement!
Compound Interest and the Rule of 72
“Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it”
Albert Einstein
When a teenager begins putting money into a retirement investment fund, they are giving their money decades to grow!
The Rule of 72: Simply divide 72 by the interest rate you hope to earn to see how long it will take for your money to double.
Example:
Ashley puts $100 of her first paycheck in a high-yield savings account earning 2.5%
72 divided by 2.5 = 28.8
It would take 28.8 years for Ashley’s $100 to double to $200
Alex puts $100 of her first paycheck into an S&P 500 index fund in her Roth IRA. Historically, the S&P returns an average of about 11%.
72 divided by 11 = 6.5
It would take only an average of 6.5 years for Alex’s $100 to double to $200. And that’s if she never even adds another penny.
If Alex puts that $100 away at 17, by the time she’s 23.5, she’ll have $200.
At 30, she’ll have $400.
By the time Alex is 60, and close to retirement, that $100 she put into her investments at 17 will be worth over $8,889! All from a simple $100 deposit at 17!
That might not sound like a comfortable retirement on its own, but imagine if Alex put an extra $100 into investments every month through the rest of high school and college. (How to Pay for College, Debt Free)
After just 5 years, she’d have over $8,000.
If she never put another penny in after college, by the time she was 65, she would have over $711,000. Now we’re getting closer to a happy retirement! And that’s without contributing anything between the ages of 22-65.
That’s the magic of compound interest and starting early!
How to Open a Retirement Fund for a Teenager
As with all things financial, a minor is unable to legally open an investment fund on their own. They need a parent or guardian.
When a teen (or child) gets their first real job, not just getting paid for chores, but real earned income, they are eligible to open a Custodial Roth IRA (Individual Retirement Account).
The account must be opened and generally controlled by a parent, grandparent, or guardian but the child will be the beneficial account owner. All funds within the account must be used for the benefit of the minor.
As soon as the minor reaches the age of maturity, usually 18 or 21 in most states, they will open an account on their own and transfer it into their own name. And hopefully, keep contributing and growing it for decades to come.
The best places to open a Roth IRA for a minor are low-cost brokerages like Vanguard, Fidelity, or similar brokerages.
From my past experience, opening a “Kids Roth IRA” is not as simple as opening one for an adult. It usually requires an extra call and a few extra forms, but it is totally worth it to get a teen investing. (Roth vs Traditional)
How Much Money Can a Teenager Put Into A Roth IRA?
Just like adults, teens and kids can put the annual federal limit into their IRA every year. In 2022, the federal limit is $6,000 or however much taxable earned income they received, whichever is less.
If 5-year-old Jonah earned $1,000 modeling for a local department store ad, he is eligible to contribute $1,000 to his IRA that year.
15-year-old Sarah who earned $10,000 working at the local Dairy Queen, can only contribute $6,000. Just like her 40-year-old dad who earned $100,000 that year.
So long it is truly earned income, and the correct income taxes have been paid, that money can be put into a Kids Roth IRA.
Can Parents Contribute to a Kid’s Roth IRA?
Let’s say 16-year-old Jeremy made $6,000 this year at his part-time delivery job but he’s a 16-year-old, he’s got expenses!
Gas, maybe car insurance, after-school burrito runs, new designer shoes that all the kids “need”, coffee with friends, etc.
(Make Your Kid a Budgeting Master)
Sure he made $6,000 but he’s not going to put every penny of that into his retirement account, that’s like a million years away!
But mom and dad know how important early retirement investments are. And that $6,000 IRA contribution limit is just going to waste if he doesn’t take advantage of at least some of it.
So mom and dad decide to help him out with some incentives.
They offer to provide a “Parent Match.” It’s like the Employer match they receive at work for their 401k but from parents.
Jeremy’s parents agree that for every dollar from work Jeremy puts into his IRA, they will match it with 50 cents.
Jeremy decides to put $1,000 of his hard-earned money into his retirement account. Mom and Dad throw in an extra $500 to match.
He now has contributed $1,500 to his IRA for the year! But he still has $4,500 worth of contributions he is eligible to add if he wants.
Birthday money from grandparents, Easter money from Aunt Sue, and pocket change from neighbor Joe can all go into his IRA for the year if he chooses. Heck, mom and dad might just be super nice and help max out his account just to help him get off to a great start!
So long as a teen or child has earned income, they are able to contribute up to their limit, no matter where the money comes from.
Avoid Lifestyle Creep and Build Retirement Habits Early
Recent research showed that young people should not be saving for retirement.
They discuss how “rational individuals allocate resources over their lifetimes with the aim of avoiding sharp changes in their standard of living.”
This means that “rational individuals” should aim to have a consistent standard of living throughout their careers.
If you are in your early 20s and only making $30,000, you should make the most of that $30,000. Spend it now and save for retirement when you start making $60,000 in your 40s.
So long your lifestyle doesn’t change at all in those 20s years, that’s a great plan!
But how many 40-year-olds, often with spouses and kids, are willing to live like they still only make $30,000 so they can put that extra money away for the retirement they never saved for yet?
It’s NOT gonna happen!
As our incomes go up, we often experience lifestyle inflation. We make more, so we want more:
- Bigger houses
- Nicer cars
- Fancier vacations
Kids bring extra expenses to the table:
- Tuition (Is Private School Worth Your Retirement?)
- Medical Bills
- Extra Curricular Activities (Stay Active for Free or Cheap)
When people put saving for retirement on the back burner for “when they make more money,” more than likely, they will never make enough money. That’s why the median retirement account in the United States is only $35,345.
Most US families can’t live on $35,000 for one year, let alone 30+ years in retirement!
Get In The Habit to Save Money for Retirement Now
By getting into the habit of saving for retirement early, teens not only give their money decades to grow, they also ensure that lifestyle creep will not jeopardize their future.
Practice putting away 10-20% of every paycheck, now, before you have actual bills and financial responsibilities. Take advantage of the fact that mom and dad are paying for your shelter, food, medical bills, and such.
Get in the habit of telling each new employer to automatically deduct 10-20% of your check for retirement, either through your company 401k or via direct deposit into your IRA.
By practicing that early and building the habit, you can actually enjoy lifestyle inflation.
Get those raises. Buy that nicer house. And know that, in the background, you’re already ensuring you can continue to live a good life in retirement without worry.
Wrap-Up
My baby sister is so excited to start her first job! It’s a big step towards becoming an adult.
I just hope that, before she gets that first check and runs out to buy new shoes, a venti coffee, and concert tickets with her best friend, she takes a few seconds to fill out the direct deposit form and hand it to her boss.
By putting that little bit of money away, each and every check, before she even sees it, she will be bettering her future life, more than she could ever know. (How I Hide Money From Myself)
What do you think? What was your first job? Do you wish you had started saving money for retirement earlier?
Leave a comment below and join the conversation!
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