Roth IRAs for Your Kids

A child, grandchild, niece or nephew, or just a younger friend with a paying summer job is likely not making a ton of money. But as a parent/grandparent/auntie/uncle/friend, you have a golden opportunity to launch them to their first million dollars. Anyone at any age with earned income is allowed to contribute to a Roth IRA.

A teen or young adult who saves $2,500 a year for 50 years will have more than one million tax-free dollars assuming their Roth account earns an annualized 7%.

Or if we assume that they save $1,000 a year for the first five years, then are able to contribute $5,000 for the next five years their Roth will be worth around $37,000 in 10 years. From there I think it’s reasonable to assume they will be able to save the maximum Roth limit each year. Though that amount is increased from time to time to keep with inflation, I am going to keep it simple here and assume that they contribute a steady $6,500 (the 2023 maximum for anyone younger than 50) for another 40 years. If they do just that they will have more than $1.8 million in tax-free dollars.

I think that’s a mighty compelling conversation starter.

Now of course, you and I know that it’s not exactly an easy sell to suggest to a teen or 20-something that they should save for retirement. This is where you come in.

Offer a matching contribution.

Anyone can help someone else fund a Roth IRA. All the IRS insists on is that the beneficiary (the kid/grandkid etc.) had earned income of at least as much as the total contribution to a Roth for any year. But the contribution can come from other sources. For example, if your child earns $2,500 in 2023 they are eligible to contribute up to $2,500 to their own Roth IRA account, even if none of the actual money comes from their earnings. Their awesome relatives, or amazing friends, can pitch in all the money. (An important note: You don’t need to be related to the beneficiary to help fund their Roth IRA. You can make this retirement gift to anyone you want, as long as they have earned income.)

My preference is that the beneficiary should contribute something. It’s how you start building the vital habit of saving. I think giving them an incentive to save is the way to go. Maybe you propose that for every $1 they contribute you will contribute $10.

Of course, this is only allowed if you yourself are in good financial shape. As for how long you keep doing this, well, that’s up to you. I happen to think it’s the best ongoing gift for a teen or young adult. Think about the legacy of this.

Show them the (future) money.

It’s so easy for them to use an online calculator to see how saving dollars in their teens and early 20s can make it so much easier to accumulate $1 million or more. I have a savings calculator on my website that brings the “magic” of compound growth into vivid view. Start with saving $2,500 a year for 50 years and a 7% rate of return. That will show them an ending balance of nearly $1.1 million. Then have them change the “years to save” to 35 years. That will show them an ending balance of less than $400,000. That’s the best illustration of the hidden trick to growing wealth: time. The more time they have for their money to compound, the more money they will end up with.

They can play around with all the variables on my free calculator. It’s going to be both educational and super motivating. I recommend keeping the rate of return at 7%. Over many decades a portfolio that mixes (mostly) stocks with some bonds has produced a higher annualized return. But I like grounding this lesson in a return assumption that may err on the side of being slightly conservative.

Help them get rolling.

If your child/grandchild/niece/nephew is younger than 18 (or 21 in some states) they will likely need to start saving in a Custodial Roth IRA. The custodial part is that the initial owner of the account must be an adult. That can be you. But once the young saver turns 18 or 21 (it depends on the state they live in) the account will be 100% theirs. Discount brokers including Fidelity, Schwab and Vanguard offer custodial IRAs. You may need to call customer service to get the paperwork rolling; Fidelity has an online signup.

Keep the investing simple.

This is also an opportunity to explain the difference between saving and investing, and how investing is only for long-term goals. Given that their retirement is likely 50 or so years off, their Roth IRA is the ultimate long-term investment. That’s an argument for owning more stocks than bonds. But first, make sure your young investor understands bear markets and is comfortable with seeing their balance fall when a bear hits. (I explain the upside of bear markets here.)

Starting with a “total stock market” index mutual fund or ETF will give them a diversified portfolio of US stocks. Every discount brokerage offers one. They’ve got time to learn more about investing and broadening their portfolio to include international stocks and maybe some bonds as well. For now, a total stock market index fund or ETF is a fantastic low-cost way to help the younger generation get rolling on saving their first $1 million.