Retirement Planning in High School? It’s Never Too Early, Experts Say

It might seem odd to open a retirement account for a high school student. But teenagers can get a big head start on long-term savings, financial advisers say, by stashing some of their earnings in a Roth individual retirement account.

Now is a good time to talk with teenagers about long-term savings using a Roth IRA because they may have earned money from summer jobs, said Patricia A. Seaman, a spokeswoman for the National Endowment for Financial Education, a nonprofit organization that promotes financial literacy.

Teenagers can benefit from tax-free growth of investments in a Roth account years before they have the opportunity to contribute to a workplace retirement plan, Seaman said. And five decades of growth allows plenty of time to ride out market swings.

“The earlier you start,” Seaman said, “the more the time value of money works for you.”

A Roth IRA for someone under 18 must be opened and managed by an adult custodian, like a parent or grandparent. The teenager must have earned income, whether from a formal job or from gigs like baby-sitting and lawn mowing. Children can contribute their total annual earnings up to $5,500.

Money in a Roth IRA grows tax-free. You can withdraw contributions at any time without paying a tax on it, but withdrawing investment earnings is more complicated. If you do so before you turn 59 1/2, you may owe taxes and a penalty, although there is wiggle room in some cases, like using the money to buy a first home. Money is contributed after tax, so there is no short-term tax benefit, unlike with a traditional IRA. But most teenagers do not earn enough to owe much in taxes anyway.

A 16-year-old may be loath to save hard-earned cash for the distant future. But parents or grandparents can help by making all, or part, of the allowed contribution on the child’s behalf; the money going into the account does not have to be the exact cash the teenager earns, said Ryan Bayonnet, a financial adviser in Akron, Ohio. (He cautioned that parents should make sure their own retirement planning is on track before funding their child’s Roth IRA.)

Or parents may “match” their teenager’s contributions, putting in, say, $2 for every $1 the teenager deposits, an approach favored by some financial experts. So if your child contributes $100, you contribute $200. Even small amounts can grow to substantial sums because of a young earner’s long retirement horizon. “The longer you wait, the more you will have to save,” said Carrie Schwab-Pomerantz, chairwoman of the Charles Schwab Foundation and a financial literacy advocate.

Advisers recommend looking for a Roth account offering low account minimums and low-fee investment options. Charles Schwab’s minimum to open a custodial IRA is $100. Fidelity Investments, which began offering a product called “Roth IRAs for Kids” in 2016, has no minimum to establish the accounts, and recently began offering zero-fee investment options, said Maura Cassidy, vice president of retirement and small business at Fidelity. Fidelity said that average balances in the accounts had grown to about $3,800 from more than $2,600 in early 2016.

Most teenagers are not likely to have $5,500 in annual earnings, but it still pays to start early. Fidelity calculated that someone contributing the maximum amount annually at age 15 would have more than $2.4 million at age 65, assuming an annual return rate of 7 percent. If that person waited to begin saving until age 25, the total at age 65 would be about $1.2 million.

Seaman said she opened Roth IRAs for her two daughters as soon as they had their first W-2 income, and insisted that they contribute 15 percent of their earnings. “I threw my parental weight around and said, ‘You need to do this,'” she said. She did not spend a lot of time preaching the tax advantages, she said; rather, her goal was to establish a savings habit.

Her message to her children: “It’s part of taking care of yourself, and creating financial freedom in the future.”

— Here are some questions and answers about Roth IRAs for children:

A: When the child turns 18 or 21, depending on the state, control of the account transfers to the child, according to Fidelity. It is important for parents to emphasize good financial habits while the account is under their control, to help create a “mental barrier” against young adults tapping into retirement accounts early, said Robert Schmansky, a financial planner in suburban Detroit.

A: Balances in retirement plans like Roth IRAs are not reported as assets on the Free Application for Federal Student Aid, the most common financial aid application, said Mark Kantrowitz, a financial-aid expert. But money taken out of a Roth account must be reported as income on the FAFSA, which could potentially reduce eligibility for need-based financial aid by up to half of the amount withdrawn, he said. Some private schools use a different financial aid form that asks questions about retirement plans, and can consider retirement plans as an asset if they choose. But, he said, “not many do.”

A: You can set up and contribute to a Roth account for money earned in 2018 until the federal tax filing deadline in April 2019.