Saving for retirement is an important way to ensure your financial security over the long run, and setting up an individual retirement account or IRA is a great way to take advantage of favorable tax provisions that can make your retirement savings grow quickly. However, in order to take advantage of IRAs, you have to meet certain requirements.
In this installment of Industry Focus, financials sector analyst Gaby Lapera and Director of Investment Planning Dan Caplinger discuss how contributing to an IRA requires that you have earned income. As Dan and Gaby describe in detail, earned income includes not just regular wages and salary payments but also money that you earn for yourself in a business, and that can allow kids with babysitting, lawn care, or other jobs to open IRAs or have their parents open an IRA for them.
A transcript follows the video.
This podcast was recorded on Jun. 6, 2016.
Gaby Lapera: IRA stands for individual retirement accounts, and everyone should have one. Right, Dan?
Dan Caplinger: Yeah.
Lapera: Since everyone should have one, can everyone have one?
Caplinger: Well, no, actually. In order to have an IRA -- whichever type you're talking about, either a traditional IRA or a Roth IRA -- the one thing you have to have is earned income. That means money that you get from a job or from a business that you run yourself. You can't set up an IRA for your 3-year-old kid. You can't contribute to an IRA if you've retired and you don't get any money from a job. But in between, the sky is pretty much the limit as far as being able to get that IRA set up for you.
Lapera: In terms of jobs, would that include babysitting money? Or is it something that you need to have a tax return for?
Caplinger: No. It includes anything that you do work in order to earn money. Babysitting, lawn work, anything like that is fair game. It's not unheard of for parents to set up IRAs for their kids based on that money that they earn, whether it's chores around the house or an outside business like a lawn care or baby sitting. That's fair game and the IRS is totally fine with you setting up an IRA based on it.
Lapera: Yeah. And I know we probably sound a little bit like a broken record here at the Fool, but it is really important to start saving as early as possible for retirement. If your kid is doing some kind of business at 12 or 15 or however old they are -- although, you should check your state's labor laws to make sure that they're legal to be working -- you should maybe think about setting up an IRA for them.
Caplinger: It's a huge gift that really keeps on giving. Every extra five years' head start that you get makes such a huge difference. Even if it's a small amount of money that you're talking about, the power of compounding, if you can find an investment that provides a solid return year in and year out, getting an extra 5, 10, 15 years under your belt by starting earlier than you otherwise would, that makes a huge amount of difference and really reduces the future burden of being able to save enough to get to where you want to be financially.