There’s nothing quite like a first paycheck.
For many teens, it comes alongside another first: weighing how to spend money they’ve worked hard for, rather than how to spend money their parents worked hard for. There’s a difference in how you process those dollars, mentally. A tank of gas turns into four hours behind the cash register. A new pair of jeans costs a day of mowing lawns.
That means a summer job is the perfect opportunity for parents to introduce kids to some smart money habits, such as saving at least a portion of each paycheck in a Roth individual retirement account. But how do you make a convincing case, especially when you’re pushing something with the word “retirement” in its name to a 15-year-old?
Here are four Roth IRA selling points to highlight. A common thread: Put the benefits into terms a teen may appreciate, such as more independence and minimal effort.
1. Investing turns money into more money
When you invest money over a long time frame, that money grows. The best part: You don’t have to lift a finger.
This is an argument with wide appeal, but you can imagine it might especially pique the interest of someone who’s just been introduced to the monotony of eight hours spent in front of a burger grill.
For 15-year-olds who invest $3,000 worth of summer job paychecks in a Roth IRA, that could grow to $4,500 by the time college graduation rolls around, assuming a 6% average annual return. The magic of investing means the money slowly adds up, whether they’re studying or at a fraternity party.
If your teen leaves that $3,000 in the Roth IRA for longer — let’s say 50 years, which would put today’s teen right around retirement age — it would grow to more than $55,000. And what if your teen added $3,000 every summer, from age 15 to 22? At college graduation, the Roth IRA balance would exceed $30,000, a figure that could grow to more than $380,000 by retirement.
Worth noting here: The Roth IRA contribution limit is the lower of $5,500 or your teen’s taxable compensation for the year. If taxable compensation is $2,000, that’s the most he or she can contribute to an IRA. This is also good to know if you decide to encourage your wary teen with an earnings match. Doing so would give the kid spending money while still putting his full paycheck in the Roth.
2. Roth IRAs are flexible
This is not the type of retirement account that swallows your teen’s money and refuses to give it back for 40 or 50 years. Because your teen would make contributions to a Roth IRA with after-tax dollars, he or she can withdraw them at any time, with no taxes or penalties.
The earnings on those contributions, like that $1,500 in the first example above, aren’t as easily recovered. Withdrawing them early typically means paying a 10% penalty and income taxes. Here’s a complete breakdown of the rules for Roth IRA early withdrawals.
The ability to withdraw contributions penalty-free makes putting money into a Roth IRA a low-commitment decision, one that your teen can reverse at any time. Of course, removing contributions will stunt or eliminate investment growth. But knowing it’s possible to get this money back could put your kid at ease.
» MORE: Want more details? Check out our Roth IRA guide.
3. A Roth IRA isn’t just for retirement
Yes, that’s the intended purpose. But on top of the flexibility of withdrawing contributions, there are a few circumstances that also allow your teen to take out earnings without penalty.
As long as the Roth IRA has been open for five years — the clock actually starts on Jan. 1 of the year of the first contribution — your child can take out up to $10,000 in earnings to buy a first home, tax- and penalty-free. He or she can also use Roth IRA earnings for qualified education expenses such as college tuition, though only the penalty will be waived in that case.
The key thing to highlight here: A summer spent pushing a lawn mower could mean not having to move back home after college graduation. At the very least, it might mean walking across that graduation stage with a little less student loan debt.
4. Qualified Roth IRA distributions are tax-free
OK, this is a hard sell, but see it through. Your teen probably just felt the burn of watching hard-earned money get siphoned off to the IRS.
The Roth IRA doesn’t help with that. Because Roth contributions are made with after-tax dollars, there’s no tax deduction on contributions as there is with other retirement accounts, like a traditional IRA. But for a low earner such as a teenager with a summer job, that tax deduction on a traditional IRA is unlikely to be worth much, if anything.
That makes the main benefit of a Roth IRA even more attractive for kids: Distributions starting at age 59 1/2 — or for that first home — are not taxed. That means as long as the rules for distributions are followed, the investment growth skirts taxes completely. And skirting taxes — even in the future — may be something they’re very interested in right now.