It's Never Too Early to Save for Retirement
Have you worked and saved your whole life with the goal of retiring one day? Have you thought about if you have saved enough money to live on for 30 years during retirement? Has it caused you stress in your life during the years leading up to the retirement decision? If you knew that if you started saving earlier for retirement, you could retire earlier, is it possible that you would have chosen a different path?
Unfortunately, you can’t turn back time, but there is still a chance for the ones you love. As the retirement landscape changes, the responsibility to save for retirement has shifted to the individual.
Will your children or grandchildren receive a pension for working for the same company for their whole career? Will social security be around to supplement their retirement savings? Will they choose a career that provides enough income to take care of a family and put money away for retirement?
We all want our children and grandchildren to have better lives than we did. As we share our knowledge and personal experiences of saving for retirement with the younger generations, we all realize that the earlier we start, the better the odds of success.
Hopefully our adult children already are on the path of saving for retirement through the use of IRAs, Roth IRA’s, or work retirement plans like a 401(k) or 403(b). What about your grandchildren?
What better gift can you give to your grandchild than to teach them about working, savings and investing at an early age? Why not help and guide your grandchildren to a successful retirement utilizing the 50 year time horizon they have to receive tax free growth available through a Roth IRA?
The IRA options for a child would include the same for as those for adults - traditional or Roth. Both these types of IRA accounts would follow the same rules as if it was an adult contributing including the income limits, contribution limits, tax deductibility, contribution deadlines and distribution rules. Each individual situation and the type of IRA that is best that individual should be considered, but for this blog I will be mostly referring to Roth IRAs due to benefit of the tax free growth.
While there is no age limit to start an IRA, the only IRS requirement is taxable compensation or earned income. Taxable compensation or earned income includes wages, salaries, tips, other taxable employee income or net-earning from self-employment. Earned income does not include interest from savings accounts or investment income, including dividends or capital gains.
The limit for IRA contributions for 2015 is the lesser of $5,500 or total earned income. The child does not have contribute the full amount that they earn, but they allowed to up to their total earned income or the annual limit on IRAs. The exact dollars that the child received from working do not need to go directly into the IRA. There is the option of working with your child to show how important saving is and matching their contribution, as long as the total IRA contribution is not over child’s total earned income or the annual contribution limit of $5,500.
Depending on how old your child, earned income can come from many different sources. Although the IRS doesn’t consider doing chores around the house and receiving an allowance as earned income, there may be other work that your child is engaging in to qualify. Does your child earn money from babysitting, mowing lawns, acting, and modeling? Are they old enough to work and have a part time job with w-2 income?
Let’s look at an example:
Let’s say that a child starts at 15 years old, contributing $2,000 a year at the end of the year for 7 years until they start working full time at age 22, and then contribute the maximum limit of $5,500 (as of 2015) at the end of the year for another 40 years. Using an average annual rate of return of 7%, the future value at the end of 40 years would be over $1,357,171. If no contributions were made until age 22 and the $5,500 contributions were made for 40 years, the future value would be $1,097,993, a difference of $259,178.
When a child has income, it may lead to filing a tax return for your child and possible tax implications, even though unlikely. For specific rules on reporting a child’s income please refer to IRS Publication 929, Tax Rules for Children found at www.irs.gov. It is best to consult with a qualified tax preparer for questions regarding specific tax treatment of a children’s income.
If the child is under the age of majority (depending on what state you live in, usually under the age of 18 but can be up to 21,) the account can be set up as “Custodial Roth,” with the parent directing the IRA for the benefit of the child. Once the child reaches the age of majority the account would transfer back to a standard IRA and the child will have full control. An IRA can be set up a qualified financial institution including banks and investment companies. Not all institutions offer these types of accounts, so don’t be discouraged if your institution doesn’t, there are many others out there.
While there are other options for children to start savings for retirement. Some grandparents open up custodian brokerage accounts for their children and grandchildren using individual stocks or mutual funds. These accounts may provide a way to save for retirement and build assets over a lifetime, but the investment income while they are a child may be taxable(to both the child and parent depending on amounts) and included when applying for financial aid.
As mentioned earlier, we all our children and grandchildren to have a better live than we did. What better option of teaching them to start saving for retirement early. Why not help them secure their successful retirement before they even start working. They may one day be able to retire without the fear and worry about if they have enough money to retire that many of us are facing now or have already experienced.
Ed Acker, CFP®, is a Client Service Advisor for Paragon Wealth Strategies, LLC. Please see his bio here: http://www.wealthguards.com/edward-acker-cfp