Retirement: Getting a Really Big Head Start
I have read numerous articles and even a few books directed at teaching children how to be responsible with money. One idea that has become somewhat popular is that of providing "matching funds" for children as it regards large purchases, such as a car. The kid works and saves and they parent fills in the gaps. I don't get too excited about many of these ideas. While I am not at all opposed to helping children get some financial footing in a tough world, you have to make sure you are helping them establish a solid foundation rather than feeding into consumerism and materialism.
However, a while back I read a matching funds idea that I really liked because it really captured the concepts of working, disciplined saving, and building wealth through long term investment. The idea presented involves offering a parent matching the savings of a working teen/young 20-something so long as they lock their saved earnings into a retirement account. 'Working,' of course refers to a teenager who is "on the books" either as an employee or by filing a schedule C.
Right now there are a number of teenagers working at summer jobs who are hopefully saving their money (a topic for another post, but I believe dependents who work should be expected to save part of their earnings). Now imagine the head start a child could get on retirement if he/she started funding their first IRA/ROTH IRA* while still young and the motivation he would have to continue to funding that IRA if he saw that reaching a benchmark or goal was manageable in both the short and long term.
Hopefully we all understand the time value of money and how a person who tries to save large amounts for retirement during their 40's or 50's may never catch up to a person who started saving for retirement in their teen's and 20's (and then stopped before the 40 year old got started). The time value of money is a wonder that never ceases to amaze me. And, there are a lot of online financial tools that can help one visualize the difference through graphs and charts.
The 2008 IRA limit is $5000. An individual can only fund their IRA up to the amount they earned. If we are in the position to do so when our teenagers start earning some of their own money, I will consider offering them a match for the amount of earnings they save and invest in an IRA. I think it would be a good investment, far better than the myriad of other ways parents "help" their children.
Given the current economic realities in the frum community, I would encourage parents to talk to their children when they start working about how important it is to save money for the future (be it for an emergency fund, a starter home, or retirement). Often there is only a limited period of time to build a healthy financial future. I see nothing wrong with showing a teenager it is do-able while the increments needed are far smaller.
*I recommend a ROTH IRA over an IRA, especially for teenagers who probably are not earning enough to take advantage of the present tax savings on an IRA anyways. If they aren't paying taxes as it is, it makes sense to use after-tax dollars and withdraw them tax free at 65+.
19 comments:
This is exactly what we're doing with my 16 year old's first job this Summer.
Even if it doesn't make a huge financial difference (he has classes part-time, so it's a part-time job), there's the time value of wisdom to consider. Having an account and watching it grow over time can be very educational.
It's also worthwhile to sensitize a teenager about what's involved in creating a lifestyle, long term.
My kids need their summer earnings to pay for their (reasonable) expenses at college. Like food and rent.
Mike S-Perfectly reasonable. Just presenting an idea that might appeal to some people. It appealed to me, but may or may not be doable as time will only tell. I would imagine your kids are learning plenty about budgeting and thinking long term too.
Though I am not a parent, high school seems late to introduce an incentive to save. My own consumption habits (frugal, but getting more so, savings rate when I was working ~35% of pre-tax earnings) were formed by the age of 8 - 9. My parents convinced me to open a Roth IRA in high school (no matching), but if I hadn't already been in the habit of saving, I doubt I would have listened.
anon: lemme guess, your allowance was more than 40cents a week...
Agree Re: Roth IRA. It makes sense at the low end of the tax bracket. I might hold that money rather than start an account for the next few months anyway.
By hold i mean in a savings acct
A simple way to match funds is to look at the kid's last paycheck of the year, and deposit an amount less than or equal to the yearly gross pay.
It can be called his (very generous) birthday or hanukah gift.
This way, there is no need to track hours or pay, and no worries about going over his actual pay limit.
It doesn't have to be his WHOLE gross pay. Matching can be for "up to $XXXX".
My father did this when I was sixteen (almost twenty years ago). The bank teller couldn't believe that a teenager was coming in to open up an IRA. "You do know you won't be able to touch the money until you are 59 1/2, right?" To this day, I put the maximum possible contribution in my (now Roth) IRA in January. I see saying for retirement as a non-negociable expense.
I clearly don't see spelling checking as required, though. What I meant was saving for retirement, not saying for retirement.
I was actually thinking of getting my daughter to put her summer earnings in a Roth IRA, but she is being paid less in total than the minimum for most mutual fund custodial accounts, and I don't see my husband ever agreeing to this. He is always concerned about locking up money and is not so thrilled withe my second idea of putting the money into a 4 year CD for 5% interest.
BTW, Julie, the teller was wrong about not being able to touch the money until the teen is 59. There are allowances to tap IRA money for college tuition and for first time purchase of a home. The only thing is that for a Roth IRA, the money comes out tax free only for retirement. But standard IRAs are only tax deferred -- not tax free -- so if someone is in a low tax bracket when facing the college tuition or purchase of the first home, tapping the IRA would not cause a large tax bite.
Some IRA accounts have lower minimums, shop around. Maybe start at Vanguard, they have low fees.
Withdrawing from an IRA (Roth IRA) has a few options:
1) After age 59 1/2. Withdraw whatever you want.
2) After age 70 1/2. Must withdraw some minimum percentage each year.
3) Before age 59 1/2. Can withdraw using Substantially Equal Periodic Payments (SEPP in section 72(t) of the tax law) for a minimum of 5 years.
4) Before age 59 1/2. Can withdraw any amount with a penalty of 10% additional tax.
5) Special cases such as first home (up to $10,000), medical expenses (maybe???), tuition payments (maybe???).
6) For Roth IRA, you can withdraw contributions (but not earnings) at any point after 5 years without penalty or taxes.
Another question - If the parents earn too much to be eligible for a Roth IRA, are children that pay tax at the parents rate (over the base amount) eligible for a Roth IRA?
Any accountants want to comment on the questions? Thanks in advance.
Mark [an engineer :-]
I would caution college-bound kids to speak with a competent advisor before doing this. From my understanding, funds can be withdrawn for higher education, and with all the problems in the financial aid industry right now, I don't think it beyond belief that the school will take this savings into account when handing out aid packages. Saving is very important but we have been discouraged from starting a college (pre-tax) account for this very reason. Tread lightly.
aml, you are correct that schools do take a student's savings into account when figuring a financial aid package. Two of my kids attended private colleges and graduate schools and all of their savings accounts had to be listed, including any IRAs. In addition, the school wanted to know about my husband's and my savings and IRAs. The amount of "free" aid was reduced because the kids could potentially tap their IRAs and so could we to pay for college. Another child went through CUNY. Although they asked about savings they were less inclined to reduce aid because of an IRA.
AML-If you are referring to the 529 plan, I don't believe that counts against the student. Talk to a financial advisor for more details.
Anyways, point well taken.
Mark-I don't believe that a child is ineligible for a ROTH IRA if the parents are ineligible. In fact, my husband opened his first ROTH while in college. I do believe he was a dependent at the time. Can't see why not since he met the dependency requirements.
Just to clarify what anonymous said about Vanguard. I recently moved my children's accounts out of there because they added on a $20 a year fee for any account under $10,000 --even IRA's. Other places, like T Towe Price only charge $10 a year and waive it for a much smaller amount -- I think half.
Once money is saved, I KNOW I'll never withdraw it; with my liquid savings it's all too easy and tempting to tap the funds for vacations, gifts, and other unusual expenditures. Odds are much of that money will eventually be spent on general consumption.
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