Quick -- at how early an age can you contribute to an IRA? Would you believe that teens can open IRA accounts as long as they have earned income and have a parent or guardian designated as a custodian of the account?
So if Junior has not earned money this year, but has received $2,000 from Uncle Fester for his birthday, he's out of luck. But if he has earned $1,000 by mowing lawns, he can contribute up to that much to an IRA. His parents might even permit him to keep all or some of the money he earned and then help him contribute up to $1,000 to the IRA, since he has the earned income to back it up.
Is it really worth it? You bet your boots it is!
Contribution limits for those aged 49 and younger are $4,000 for 2006 and 2007. (For those 50 or older, it's $5,000.) Let's say a 15-year-old earns $3,000 in 2006 and wants to contribute $3,000 to an IRA. Here's how it would work in a traditional and a Roth IRA:
- A traditional IRA is one in which you park "pre-tax" money, and the money you invest grows in a "tax-deferred" manner. This means that you can buy and sell stocks or funds in your account and can generate capital gains, but you're not taxed on them -- yet. You don't get hit by taxes until you start taking your money out at retirement. (If you try to take money out before you hit retirement age, you get socked with penalties, as well as taxes.)
- With a Roth IRA, you invest "post-tax" money in it, and you're supposed to leave that money invested in that account until you hit retirement age. At that time, you can start withdrawing your money -- not tax deferred, but tax free!
If the 15-year-old's $3,000 is invested in the stock market and earns the market's historical average of about 10% per year, in 45 years (when he's 60) it will have grown to more than $200,000! In a traditional IRA, it would be taxed upon withdrawal -- but in a Roth IRA, he'd ultimately get to withdraw it tax free. (Remember that with the Roth, the money is contributed on a post-tax basis.)
Play with some of these numbers in your head and you'll quickly get a sense of how powerful an IRA can be for someone with a lot of time to let investments grow. Investing your teen's $10,000 to $20,000 over the next couple years can set them up with a million dollars or more for their retirement
Learn much more about IRAs in our IRA Center, which offers a detailed comparison chart on brokerages, as well as lots of information on Roth IRAs, traditional IRAs, and more. A recent Newsweek article listed some brokerages that offer IRAs for minors: T. Rowe Price, Vanguard, Schwab, and E*Trade.
We've covered the critical topic of IRAs many times in Fooldom. Here are some articles that may be of interest:
Also useful is this Tim Hanson article, where Tim describes how he set up his own IRA to operate on autopilot, investing in exchange-traded funds that focus on the broad market and emerging markets. If you're looking for ideas on ways to invest your IRA money, he presents some good food for thought.
For more about longtime Fool contributor Selena, view her bio and her profile. You might also be interested in these books she has written or co-written: The Motley Fool Money Guide and The Motley Fool Investment Guide for Teens . The Motley Fool is Fools writing for Fools.