With summer break upon us, many high school and college students are just beginning summer jobs or internships. While the thrill of earning a paycheck is undeniable, it also presents a fantastic opportunity to introduce your child to the principles of saving and investing.
One excellent way to do this is by opening a Roth IRA and contributing some of their summer earnings. Not only can they jump-start their retirement savings today, but they’ll also receive a valuable lesson in building long-term wealth.
Why a Roth IRA?
Roth IRAs are one of the most powerful ways to save for the future and have incredible tax advantages and flexibility, making them an ideal choice for young savers.
Here are some key benefits:
Tax-Free Growth & Withdrawals
Unlike traditional IRAs, whose contributions typically receive an upfront tax deduction but are taxed at withdrawal, Roth IRA contributions are made with after-tax dollars, and withdrawals in retirement are completely tax-free. In both cases, investments within the IRAs grow completely tax-free from year to year, allowing the powerful effects of compounding to work their magic.
Penalty-Free Withdrawals of Contributions
Understandably, some kids might feel reluctant to lock up their hard-earned money for 40 or 50 years. While ideally, this money will grow untouched until retirement, your child can withdraw up to the total amount of their contributions at any time, for any reason, without incurring taxes or penalties. This provides a safety net if they need access to their money in an emergency.
If your child withdraws funds from their Roth IRA that exceed their contributions before age 59 ½ or before the account has been open for five years – dipping into investment growth – they may owe taxes and a 10% early withdrawal penalty on the earnings portion of the withdrawal. However, there are exceptions.
Exceptions to Early Withdrawal Penalties
There are several scenarios where your child can withdraw funds early without penalties (though taxes on earnings may still apply), including:
- Qualified higher education expenses—Tuition and fees for community college, trade schools, and 4-year colleges and universities are all considered higher education expenses. Unfortunately, room and board and transportation costs are not eligible.
- First-time home purchase – (up to a $10,000 lifetime limit). As long as the Roth IRA has been open for at least five years, there are no taxes or penalties for withdrawing funds for a first-time home purchase.
- Disability
- Certain emergency expenses
- Paying health insurance premiums or unreimbursed medical expenses if you’re unemployed.
These exceptions make a Roth IRA a versatile tool for young savers who might need access to their funds in the future while still planning for long-term wealth.
Eligibility and Contributions
To contribute to a Roth IRA, your child must have earned income that is officially reported to the IRS, so unfortunately, cash jobs like mowing lawns or babysitting don’t qualify. The maximum contribution for 2024 is $7,000 or the total of their earned income, whichever is less, and contributions for 2024 need to be made by April 15, 2025.
Parent “Matching” Contributions
For families with the financial resources to do so, we encourage setting up a “matching” program with your child to incentivize them to work and save. Perhaps for every dollar they earn, you contribute $0.50 to their Roth IRA on their behalf, or even better, a 1:1 match!
For example, if your child earns $3,000 working as a camp counselor over the summer, they could keep those earnings for themselves, and you could “match” those earnings by contributing $3,000 to a Roth IRA on their behalf. As long as total contributions to the Roth don’t exceed the amount your child earned in 2024, any individual can make the contributions.
The Logistics of a Roth IRA
We recommend setting up a “Custodial Roth IRA” at a custodian like Charles Schwab, which can be done easily online in a matter of minutes. Until your child reaches the age of majority in your state (21 in Oregon), the account must be managed by a parent or other adult.
Aside from the flexibility and tax benefits, the real power of a Roth IRA is the ability to invest contributions for the long term. While the choices are virtually limitless—individual stocks, mutual funds, ETFs—we recommend selecting broadly diversified and low-cost investments. No matter what type of investment you choose, this is a great opportunity for your child to learn the basics of investing and cultivate a habit of saving and investing.
Start Saving Today
If you’re interested in discussing the benefits of opening a Roth IRA for your child or grandchild, feel free to reach out – we’re here to guide you through the process.
Uplevel Wealth is a fee-only, fiduciary wealth management firm serving clients in Portland, OR, and virtually throughout the U.S.
