[Updated October 12, 2022]
What’s the best way to introduce your kids to investing?
It used to be with stock certificates—elaborately engraved documents that served as physical proof that you owned shares of a company—often proudly framed and displayed in a child’s bedroom.
While stock certificates for kids are less common today, there’s another way to get them excited about investing.
Set up a Roth IRA when your teens start their first summer job.
Why a Roth IRA?
Funded with post-tax income, Roth IRAs give teens a huge head start on saving for retirement. Income grows tax-free, and funds withdrawn at retirement are not taxed.
Parents can open a Roth in a teen’s name. To qualify, the teen must have earned income that does not exceed $144,000—a pipe dream for most kids.
The Power of Compound Interest
Albert Einstein famously said, “Compound interest is the eighth wonder of the world. He who understands it, earns it…he who doesn’t…pays it.”
To illustrate this, let’s say that your 18-year-old invests $6,000 of savings from their summer job this year in a Roth IRA. Assuming an 8% annual return, he or she would accrue approximately $150,000 by age 60.
When they catch on to the power of compounding early in life, teens can enjoy decades of watching their wealth grow.
Individuals can contribute a maximum of $6,000 each year to a Roth IRA (up to age 50 and then $7,000 after that).
While few teens can maximize Roth contributions on their own, parents, grandparents, and other relatives can help. Matching your child’s contributions is a great way to incent saving.
One caveat: The most your child can deposit (his or her money plus anything you contribute) is what he or she earned during the year, up to the $6,000 limit.
The Making of a Millionaire
If an 18-year-old opens a Roth IRA with $6,000 and continues contributions at the same level every year, he or she would be a millionaire by age 52, assuming an 8% annual return.
This could motivate even the most apathetic teen to save. If not, a friendly reminder might.
An 18-year-old who invests an initial $6,000 and nothing more would have only $82,000 by age 52—a far cry from the cool $1 million that the same 18-year-old would have if he or she consistently maximized contributions during this same time period.
Better than a Stock Certificate
To paraphrase a wise line by Albert Einstein – compound interest is the eighth wonder of the world. The person who understands it, earns it… the person who doesn’t… pays it.
Opening a Roth IRA can be one of the best gifts you ever give your teen. Your child won’t get that colorful stock certificate, but he or she will get something infinitely more valuable—a lesson in how to build a stable financial future.