While not all kids will be thrilled to learn about investment principles and their importance for retirement, teaching them early can pay off both financially and educationally. Thankfully, there are many ways for children to earn money, invest effectively and achieve better returns by investing for retirement early in life. Your kids may have their whole lives ahead of them, but a child who understands the ins and outs of investing now might go on to do big things with their growing wealth in the future.
It’s not necessary for a child to invest a fortune to see serious returns on their investment. In fact, investing only a small amount for retirement as a kid can result in huge returns later on. One of the most effective investment vehicles is an IRA.
Kids are actually permitted to open a Minor IRA retirement account as long as they are earning income, but in most states, you will still have to serve as the guardian of your child’s account until they turn 18. Not all investment firms offer IRAs for kids, but some allow you to open a custodial account for as little as $100.
It’s important to remember that a child can only contribute money they earn to an IRA account. Only money earned through babysitting, raking leaves, shoveling snow or other similar activities can actually be invested. Unfortunately, money from a kid’s birthday or allowance is not eligible. As a result, it’s important to ensure your child is keeping detailed records of their earnings as they invest in their account.
Earning Big Bucks Over Time
A kid that invests as little as $2,500 in an IRA at 12 years old could retire with approximately $90,000 at the age of 65, assuming a 7 percent average annual return. However, kids and teenagers can earn even more by contributing just a little bit annually. Let’s say they start with $5,000 at the age of 14 and contribute only $100 annually until the age of 65. Assuming a 7 percent annualized return, they would retire with a whopping $205,000.
It’s also important to explain to your child the importance of not waiting too long to invest in life. For example, a 30 year old investing $5,000 and contributing $100 a year will retire at 65 with only $50,000, assuming a 7 percent rate of return.
Ultimately, these figures serve as a lesson on how time and compounding interest can really lead to massive returns later in life. A child might not immediately appreciate the finer details of investing and retirement, but once you show them the money they could end up with, you might just spark a lifelong love of investing.
Choosing Between Different IRAs
The traditional IRA and Roth IRA are both available for minors. The Roth IRA allows a child to pay taxes on money when they first put it into their account, and then withdraw their earnings when they retire without paying taxes. The traditional IRA is basically the other way around, and allows a contributor to avoid taxes with their initial contributions, but will mandate they pay a certain tax rate when they retire. The traditional IRA also provides an up-front tax deduction at tax time.
In a given year, if your dependent child earned more than $6,200, they may have to file their taxes. However, most children don’t earn that much. So, in most cases, a child can benefit more from a Roth IRA investment. If your kid is earning more than $6,200 a year, you might want to think about enrolling them in a traditional IRA for the tax deduction it provides for earned income.
While helping your kids save for retirement with an IRA and teaching them about taxes, savings and earning power might not automatically make them rich, it will give them a big head start in life. In the end, your child will appreciate the effort you put in toward giving them a brighter future.