How Kids Can Save Millions For Retirement With a Minor Roth IRA - March 26, 2013
When my daughter was 9 years old, she earned her first chunk of money by pet sitting for vacationing neighbors. In 2011, she earned $500 and filed her first tax return. In 2012, she earned $320 and filed another tax return. By filing a simple 1040EZ, all that money became eligible to contribute to her own Roth IRA. That means she is looking at a minimum of 50 years of tax-free compounded gains. Her effective tax rate happened to be ZERO, but this is now officially post-tax money and she will keep every penny of gains that will compound for the next 50+ years. As a very young person, time is one her side–to the extreme. $500 compounded for 50 years at 9% (very attainable by automatically reinvesting dividends in high-yielding stocks like utilities) will transform into $37K tax-free dollars. Once she is old enough to earn a little more money and make the maximum Roth contribution every year, it will be easy to project many millions of dollars ($5K contributed per year for 50 years at 9% results in $4.8M).
Here is your checklist to get going:
1) Kid earns some money working for friends and neighbors.
2) Parent helps kid open a Minor Roth IRA. The Minor Roth IRA is for people under 18. The parent will be the custodian of the account until the kid is 18. Not every brokerage is aware of these accounts, but OptionsXpress (Charles Schwab) is a great choice because they know about them and don’t have any fees to open or maintain the account.
3) Kid files a federal tax return. If your kid doesn’t have any income other than helping friends and neighbors, then she can file a 1040EZ and it will only take a few minutes to fill out. In the section where you would normally show your W-2 from your employer, you just write “HSH 320″ which means $320 of household income. See my 2012 example 1040EZ here.
4) In Ohio (check with your state), you do not need to file any state return if you make less than $11,700.
5) Deposit your kid’s entire 2012 income to her Roth IRA account and help her purchase a high-yielding stock with low risk (think utilities, consumer goods, etc.)
6) Make sure your Roth IRA brokerage account is configured to automatically reinvest dividends.
Here are some more ideas to help get your kid excited about saving and investing:
* Show her the difference between a 10-year-old and a 40-year-old both saving $500 per year until age 60. This will demonstrate the power of time and the value of being a young kid. (40-year-old saves $30,684 while the kid saves $481,399 at the same rate of 9%)
* Show her stocks that have been huge gainers that she could have identified early on (Apple, Chipotle, Panera, Five Below)
* Show her the difference between keeping all your money and paying out a large percentage to taxes.
* Show her how to learn from other peoples’ successes and mistakes (you probably have some people in your family who are good at saving and some who are bad at it!)