Happy National Teach Children to Save Day! With summer job season fast approaching for high school and college students, now is an excellent time to teach your youngest loved ones a life lesson about the benefits of putting money aside in a Roth IRA.
While the notion of retirement seems unfathomable to anyone under forty, investing in a Roth IRA and becoming a millionaire—or better yet a multimillionaire—would get anyone’s attention. As such, there are two primary reasons why a Roth IRA is a great starter investment for teens and young adults: Taxes and the power of compound growth.
A student working for the summer or just starting their professional career is likely in one of the lowest tax brackets. Therefore, they may be better served paying taxes on their income now in return for tax-free growth in a Roth IRA over the course of several decades.
The Roth IRA Path to Millions for Teenagers
Personal tax rates are probably going in one direction: Up.
Even a relatively modest annual contribution of $1,000 starting at age 15 could grow to over $417,000 by age 70, assuming an average annual return of 6%. Bump those annual contributions up to $6,500 (the maximum currently allowed for investors age 49 and younger) and those savings could grow to more than $2.3 million by age 70.
To illustrate what a great starter investment a Roth IRA can be, we set up several different scenarios in the table below. All of them assume a 6% average annual return. The only difference between these scenarios is the amount contributed per year, which increases in five increments from $1,000 to $5,500 from age 15 to age 70. As you might expect, the greater the contribution and the longer the time horizon, the larger the account grows. Bigger initial (and subsequent) investments result in even more impressive balances.
Roth IRA Results May Improve With Age
| Age | $1,000/year | $2,000/year | $3,000/year | $4,000/year | $5,500/year | Increasing Contributions |
|---|---|---|---|---|---|---|
| 15 | $1,000 | $2,000 | $3,000 | $4,000 | $5,500 | $1,000 |
| 30 | $24,673 | $49,345 | $74,018 | $98,690 | $135,699 | $33,126 |
| 60 | $225,508 | $451,016 | $676,524 | $902,032 | $1,240,295 | $567,960 |
| 70 | $417,822 | $835,645 | $1,253,467 | $1,671,289 | $2,298,023 | $1,093,974 |
Sources:
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Mitchell, C. (2024, January 8). Historical average stock market returns for S&P 500 (5-year to 150-year averages). TradeThatSwing.
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4. Real Estate Investment Trusts: Nareit. (n.d.). Annual index values & returns.
5. Hedge Funds: Perry, M. J. (2021, January 7). The SP 500 index out-performed hedge funds over the last 10 years. And it wasn’t even close. AEI.
Uhlfelder, E. (2022, July 25). The most consistently profitable hedge funds continue to prove their edge. RIA Intel.
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We also developed another scenario that attempts to show a conservative, natural progression a young person might follow as they age and work (see the “Increasing Contributions” column). It starts by assuming they get a first summer job at age 15 and invest $1,000 a year until they graduate from college and get settled into a career. At that point (age 25), they bump their annual contribution up to $2,000. They will (hopefully) be well established by their 30s and able to again bump their contribution up to $3,000 at age 30, $4,000 at age 35 and $5,500 at age 40. The table assumes they continue to contribute $5,500 per year through age 70.
Those who follow this hypothetical progressive contribution strategy could end up with more money at age 70 ($1,093,974) than those who contribute $2,000 per year from age 15 on but never increase their contribution ($835,645).
Roth IRAs Are More Flexible Than Traditional IRAs
The idea of tying up savings in an IRA may not appeal to a teenager or a young adult who may need to pay for new car or later even a wedding or a down payment on a first home. With a Roth IRA, however, the rules do provide some flexibility.
Contributions to a Roth can be withdrawn penalty-free at any time. (Of course, that defeats the purpose of saving in a Roth IRA, but the ability to access cash in a pinch may be a selling point for your teen.) In addition, a Roth owner can withdraw up to $10,000 in earnings on contributions after five years for a qualified first-time home purchase. Earnings can also be taken tax-free after five years for disability, death or once the account owner reaches age 59½. Keep in mind, however, that nonqualified withdrawals on earnings taken for any reason prior to five years are subject to a 10% early withdrawal penalty and are taxed as ordinary income.
Social Security provides a continuous income stream in retirement, and the dependable monthly payments might help you cover certain routine expenses or health care premiums. However, your Social Security might represent just a fraction of your expected retirement income. Multiple income sources can push you into a higher tax bracket if not managed carefully, so it’s essential to claim your Social Security strategically to mitigate potential tax implications.
Getting Started
The scenarios described above demonstrate the benefits of investing in a Roth IRA starting at an early age. Nevertheless, the question remains: How do you inspire a teenager to plan ahead and start saving?
Our suggestion is to lend a helping hand (or dollar, in this case). Assuming you can afford to match the summer earnings of a loved one, why not do it? Let them keep some of their hard-earned wages—open a Roth IRA in their name and contribute. Remember, a young person may earn $1,000, but taxes will reduce take-home pay. That shouldn’t keep you from contributing a full $1,000 into a Roth IRA, though. (Note that contribution amounts cannot exceed the account holder’s earned income for the year.) If you cannot contribute the full amount yourself, or if you think it will teach some fiscal responsibility, consider making a deal with your teen to match a portion of their earnings as long as they contribute to their Roth IRA as well.
Helping the teenagers and young adults in your life start on the road to a comfortable retirement may be one of the best gifts you can give them. Along the way, you will also be teaching them fiscal responsibility and the importance of long-term financial planning from an early age.
If you are a client, please reach out—we’d be happy to help you set up a Roth IRA for a young saver or assist in any other way.
If you are not a client, click here to start a conversation with one of our expert financial advisors.
Think of the current estate tax breaks as a limited-time offer.
The current tax code has an expiration date, and the sunset is approaching faster than a filibuster in a contentious Senate debate.
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