Last year, I started teaching high school English -- a completely different animal from the university courses I used to teach. One of the biggest differences is that I get to know my high school students much more thoroughly than I ever knew my university charges. I hear about their families, loves, fears, hopes -- and quite a bit about their part-time jobs.
And while I'm teaching them about narrative structure, alliteration, and irony, I'm also wondering whether they've started a retirement account yet. Do they know about the Roth IRA? Do they have any idea what an advantage their youth is? I have to find a way to slip a spreadsheet into their journals somehow.
So this is for you, teenagers. If only I knew at age 17 what I know now.
Retirement isn't just for geezers
I realize that you can't possibly be concerned with retirement at your age. That's more years ahead of you than you've even lived yet. You've got plenty of time to think about that after you've finished college, after you have a good job, and after you've bought a house and a nice car, right? Well, maybe, but let's look at what you can accomplish if you give it some thought now.
One of the few genuinely sweet deals the government has given us is a beauty called the Roth IRA. The traditional IRA is a retirement account that gives you a little tax break each year on the amount you deposit toward your golden years. But when you do retire and start pulling that money out, you'll have to pay income taxes on the withdrawals -- including all the profits you've racked up through years of Foolish investing.
The Roth IRA, however, works a little differently. You don't get any tax break each year when you deposit a portion of your earnings. ("How is that a sweet deal?" I hear you ask. Patience, Grasshopper.) But when you start withdrawing the money at retirement from a Roth IRA, the income taxes haven't just been deferred, they've been eliminated entirely, because you already paid taxes on the money as you earned it. That's right. The money you withdraw at retirement -- including all the growth from your investment prowess -- is completely tax-free. Sweet? Yeah, sweet!
So, you want $5 million?
Now I realize that talking about tax savings at some distant date doesn't fire you up enough to run out and sign up. You're 17; you've friends to text, calls to make, empires to build. But let's look at a few numbers that might catch your attention for longer than it takes you to forget which short story I assigned you to read for class tomorrow.
Taylor is our teenage Fool poster child. Taylor is 17 years old. She works 15 to 20 hours a week at the local coffeehouse during the school year, and a few more hours per week over the summer. Over the course of the year, she earns roughly $7,500. By law, she's entitled to put up to $4,000 of her earned income into a Roth IRA each year, but let's be realistic. She's a teenager. Have you seen her wardrobe? That girl can shop!
Even though she's a walking fashion statement, Taylor's not entirely a spendthrift, and she does have one eye focused on her future. So let's assume that somehow she manages to save $2,000 of her annual wages for her Roth IRA.
And because she is a full-time student, part-time barista, and full-time teenager, she doesn't have the time to choose her stocks individually. Instead, she opts for a baseline investment strategy of investing in the major market itself. So we'll work from the assumption that Taylor will earn the same return as the overall market itself -- that is, somewhere between 10% and 11% a year.
So every January, Taylor invests her $2,000 and racks up another 10% profit during the year. Any idea how she'll be fixed for her golden years? Let's look. When she hits her 60th birthday, she'll be sitting on a portfolio -- 100% tax-free -- of $1.3 million. (I'll give you a minute to swallow.)
And that's assuming she never saves a penny beyond her $2,000 a year her entire career, and that her returns are only 10% a year, slightly below the S&P 500 Index's record over the last 80 years. Imagine how much better off she would be if she Foolishly invested more than that minimal tally, recording even better annual returns!
In fact, don't even guess. Let's actually look at the differences. Assume that Taylor is a freak of nature and manages to invest the full $4,000 a year. (After all, no one says Mom and Dad can't pitch in and help her retirement fund in the early years.)
Keep the same assumptions about Taylor's annual returns (10%), and suddenly her retirement account swells to $2.6 million on her 60th birthday. Keep in mind that we're talking about $2.6 million with no income taxes attached. Most teenagers will sit up and take notice if you dangle a $3 million carrot in front of them.
But let's push the scenario one step further. Let's assume that Taylor's so excited about her prospects that she's not satisfied with market returns. She hangs out with Fools online, does her homework, picks up some of the best ideas from the Fool's newsletters and from the message board discussions. As a result, Taylor ends up beating the market returns over time.
Instead of 10% a year, let's assume Taylor bumps her average returns up modestly to 12% a year. (Let's see . carry the one, remainder of two, round off to the nearest dollar .) Wham! That $2.6 million suddenly balloons to more than $5 million.
The best gift for your kid
Is it really possible? Of course. You don't have to be a prodigy investor; returns of 10%-12% won't put anyone into the investing hall of fame. It's just a matter of time and consistency. By putting away a reasonably modest amount every year for decades, and achieving a decent average return, Taylor's retirement will truly be special.
I don't know many teenagers whose eyes won't go wide at the prospect of $5 million. And if you're a teenager, the best time for you to start is today. The next best time is tomorrow. Don't wait. If you're a parent of teenagers, help light that fire under them today. It's one of the best gifts you can ever give them.
Robert Brokamp , our lead advisor for Rule Your Retirement , started planning for retirement in kindergarten. It's no surprise that he feels it's never too early to start saving for your golden years. To take a risk-free trial to Rule Your Retirement, click here.
Fool contributor Robert Sheard, author of The Unemotional Investor and Money for Life, was halfway to Geezerville when he first discovered Foolishness. But his teenage son is going to be all over the Roth IRA from day one of his working career.