Today, I’ll discuss the six steps I followed to open a Roth IRA account for my teen to celebrate the financial literacy month.
Originally published in Retirement Daily
Last July, I gave you 6 Reasons Why Your Teen Needs a Roth IRA Account.
In this post, I’ll outline the six steps I’ve taken to make this a reality for my teen. She worked this past summer and made a decent amount of money. Remember they just need earned income to be able to open the account.
It really doesn’t matter how much your teen makes; the key thing is to get them started on the path to associating earning income as something that’s followed by investing some of that cash.
STEP 1: Talk with Your Teen About Investing
When your teenager starts working, there are a lot of competing “needs” for that money. It’s probably the most amount of money your teen has had to manage on their own.
Hopefully, you’ve been talking to them about the basics of money, saving, investing, etc., making this a continuation of the conversation.
Talk to them about how investing works, and especially how compound interest works. There is a reason Albert Einstein called it the “most powerful force in the universe.”
The article “10 Reasons why Compounding Interest is the 8th Wonder of the World” (1) is one of the best resources I have read on the subject. The article is an easy read for beginners and teens.
Discuss the possibilities of what the future money can do for her, and to make it even sweeter, use real numbers. The handy compound interest calculator on investor.com (2) is brilliant for showing them how their money will grow.
For example, a one-time investment of $5,000 at 8% interest rate will grow to $121,366 in 40 years.
If they ask questions on investments or want to learn more here are a couple of books you can share with them.
STEP 2: Learn the Wonders of the Roth IRA Account
Move on to explain the basics and the benefits of the Roth IRA account, especially if they have questions on taxes. My previous article Explaining the Benefit of a Roth IRA Account for a Teen is a great start.
For more on Roth IRAs, other IRA accounts and what you can or cannot do with them, check out the IRAs & ROTH IRAs resource page.
STEP 3: Choose a Roth IRA Custodian and Open the Account
There are a lot of online options for this. You want a custodian that has the following:
Wide investment selection
Good customer service
Examples of online options are Vanguard, Fidelity, Charles Schwab, TD Ameritrade, Altruist and many more. Don’t complicate this one, pick one and go. I went with TD Ameritrade, as I already have an advisor relationship with them.
If your teen is a minor, open a minor Roth IRA. If she is 18 and in some states 19, she can open the account on her own. But it’s still worth guiding her, to ensure it’s done.
STEP 4: Fund the Roth IRA Account
Our combined goal is to keep adding money to the account, so we linked her bank account and pulled in the money as a lump sum, once she decided how much she was going to invest. I’m also giving her access to be able to log into the account anytime and see how things are progressing.
She can invest up to $6,000, but not more than her earned 2021 income. Letting her know she can log in anytime and do the actual transfer gives her some control, which you want with this group.
To sweeten the deal and keep encouraging her, I’m matching her dollar-for-dollar of whatever she puts into the account, this year. So, if she deposits $1000 dollars, I’m going to deposit $1000 dollars into the account. With her depositing $3000, we’ll easily max out her 2021 contribution, which is great!
STEP 5: Start Investing
Now the fun begins. I’m keeping this as simple as possible, and we’ve agreed I’ll invest about 70%-80% of the money. I get to pick what to invest that money in. She is free to pick the investments for the other 20-30%. I’m happy to let her do more, just go with what works for your family, and focus on the larger goal.
The investment choices she makes, will allow for future, more advanced conversation on investing. A win-win situation.
At this point the goal is for her to learn how investing works, using real money after doing some research on her own. We are not concerned about tax implications since a Roth account is tax-free.
We’ve established a few ground rules, but she has a lot of freedom on this portion of the money. She is welcome to compare notes with me and I’m happy to discuss how things are going anytime.
STEP 6: File 2021 Taxes
For 2021, the threshold for filing taxes on regular income (W-2) is $12,550 which is the standard deduction. If they earned below that, it may not be necessary to file taxes but if the employer withheld any taxes, the only way they are going to get that money back is to file taxes.
Plus, I think it’s a good teaching opportunity on how taxes work. Her employer is giving her W-2s, so we are going to file her taxes for her.
If the income is from self-employment, like doing odd jobs around the neighborhood, the threshold is a lot lower. They need to file taxes if their income is $400 or more. The beauty of self-employment income is you can start teaching them all about business deductions.
If you end up not filing taxes, be sure to keep meticulous records of their income, in case questions were to ever come up.
Follow the steps above, and you have a chance of creating a millionaire in addition to having a financially literate adult.
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Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, investment advisory services or legal advice. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Jane Mepham and all rights are reserved. Read the full disclaimer here.