Q&A: Does a teenager need a Roth IRA?

Dear Liz: Our 16-year-old daughter has been frugal since she started understanding money at about age 6. She works and makes a decent income for a high school student. Her savings are now quite substantial. She wants to open a Roth IRA while she is young and has no income tax liability. My wife and I have pensions and substantial savings but only one IRA. So we have no idea how to help her open a Roth. What should she do? She has enough money to maximize her contributions every year through high school and college and wants to take full advantage of 50 years of tax-free growth.

Answer: Contributing to a Roth IRA is an excellent way for young people to build wealth, and the earlier they can start, the better.

Traditional IRAs typically offer a tax deduction for contributions but withdrawals are taxable. Roth IRAs, by contrast, don’t offer an upfront tax deduction but withdrawals are tax free in retirement. Opting for a Roth over a traditional IRA makes sense when you expect your tax rate to be the same or higher in retirement.

A $6,000 contribution at age 26 can grow to about $105,000 by retirement age, assuming 7% average annual returns. (That’s a reasonable average for a multi-decade investment in a diversified stock portfolio.)

Make the same contribution at age 16, and the money could grow to over $210,000 by age 67. The extra 10 years of compounded gains effectively doubles the total.

To contribute to an IRA or Roth IRA, people must have earned income such as wages, salary or self-employment income.

They’re allowed to contribute 100% of their earnings during the tax year or $6,000, whichever is less. (People 50 and older can make an additional $1,000 catch-up contribution.) If your daughter earned $4,000 this year, for example, that’s the maximum she could contribute to a Roth for 2021.

Your daughter typically can’t open her own account until she’s 18, so you would need to find a brokerage that offers custodial Roth IRAs. She would be the account owner and you would be the custodian until she turns 18. Fidelity, Schwab and Vanguard are among the discount brokerages that offer custodial Roth IRAs without requiring minimum investments or charging maintenance fees.

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