Few teenagers think much about retirement, but funding an Individual
Retirement Account may be one of the best financial steps they will ever
take. The reasons are simple - taxes and time.
IRAs can be established by individuals of any age. The only requirement is
that they have earned income equal to or exceeding the amount they contribute
to an IRA. Contributions to regular IRAs can be tax deductible, but most
teens have low enough incomes that much of their income is not subject to
tax; or if it is, the tax rates are low. Roth IRAs are especially attractive
for younger individuals because they offer the potential to accumulate funds
that, if handled properly, will never be subject to income taxation.
The Basic Rules for Roth IRAs
Contribution Limits - For the taxable year of 2005, you
can contribute up to $4000 to a Roth IRA. You must have wages (or other
earned income) equal to or greater than your contribution. The annual
contribution limit is scheduled to increase beginning in 2008.
Deductibility - Contributions to a Roth IRA are not
deductible.
Earnings within the Roth IRA - Earnings on the funds
within the Roth IRA are not subject to income tax. This enables your funds to
grow faster than they would in a taxable account.
Distributions from a Roth IRA - The significant advantage
of a Roth IRA compared to a regular IRA is that distributions from the Roth
IRA are not subject to tax provided you meet certain rules. Generally, if you
take distributions after reaching age 59 ½, they are tax free. In
addition, there are some rules that allow for distributions earlier if the
funds are used for first home purchases or qualified education expenses.
As with most income tax issues, the actual rules can be complex. You may
want to consult with your tax advisor for more details.
Putting Time on Your Side
The longer the funds remain in a Roth IRA, the larger the balance can
become. For younger individuals, this can be very significant.
Consider these scenarios:
Let us assume that Sue has a part-time job for her last two high school
years and contributes $3000 in those two years. If she earns 8%, when she
reaches age 60, her Roth IRA would have grown to over $180,000.
Now let us assume that she continues to work part time while going to
college for four years. In this case, Sue would have accumulated almost
$465,000 at age 60.
These large accumulations are possible because the money compounds for such
a long period of time.
Putting This to Work
It is easy to establish a Roth IRA. Just visit your financial institution.
You may even want to consider giving the child money for their contribution.
Just remember that the individual must have wages at least equal to the
contribution.
What a wonderful way for a young person to start on the road to financial
security and to start a saving pattern that will provide returns for the rest
of his or her life.
