If your teenager is working hard at a summer job, they may be eager to spend that money right away. But it might be a good idea to help them tuck some of that money away for future investments. Chartered Financial Consultant and Managing Partner at Penn Mutual’s Caserta & de Jongh, John Caserta, shares his tips.
* First, make sure your child is eligible to open an individual retirement account (IRA). According to the Internal Revenue Service (IRS), the child must have earned income during the tax year to open an account, which is defined as all taxable income and wages you get from working.
* Next, help your child develop a budget that includes line items for retirement savings. Creating such a budget will help reinforce the idea that they should pay themselves each month just as they would pay any other bill. And while experts recommend saving 10-15% of gross earnings toward retirement, you can actually contribute 100% of earnings to an IRA up to the current limit of $5,500.
Opening an Account
* For minors, a parent will have to be the custodian on the account, which means that the parent will be responsible for managing the account and choosing the investments.
* While there are numerous firms that offer self-directed brokerage accounts, some may choose to work with a financial advisor in helping them choose and manage the investments inside the account.
* There are two types of individual retirement accounts, including a Traditional IRA and a Roth IRA. In many cases, a child will not need the tax deduction offered by a Traditional IRA and the flexibility of a Roth IRA may be more appealing.
Using the Money
* Even though the accounts are designated for retirement, the money can be accessed in certain cases prior to retirement such as emergencies, buying a house, or going to school. The type of account and the reason will determine whether you will pay taxes and/or penalties on the distribution.
* Any contributions to a Roth IRA can be withdrawn at any time for any reason without tax or penalty. In contrast, earnings that are distributed before 59 ½ and before the account is five years old may be subject to taxes and penalties.