Why a Roth IRA is a Game-Changer for Your Teen's Financial Future

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There is no more lucrative financial move than to have a teenager or young adult open a Roth IRA.

Now I know that may be a hard sell. Suggesting someone that young open an investment account for their retirement does sound a bit, well, crazy.

But it is crazy smart. And for the parents and grandparents out there who have the money to deliver an enticing “matching contribution” I think you have a fantastic way to encourage and help your kid/grandkid make this insanely smart decision.

First, let’s cover the rules.?

• Any individual under the age of 50 with earned income below $146,000 in 2024 is eligible to fund a Roth IRA.
• The amount you can contribute to a Roth IRA is limited to your earnings, up to a maximum 2024 contribution of $7,000 for anyone younger than 50. For example, if your teen makes $2,500 this summer, they can contribute up to $2,500 to their own Roth IRA. If you have a young adult who manages to earn $9,000 in 2024, the maximum they can contribute is $7,000. (I want to be clear: EVERYONE with earned income can contribute to a Roth IRA, not just young adults. In fact, if you are at least 50 years old, you are allowed to contribute more each year than younger people. In 2024 the maximum contribution for anyone at least 50 years old is $8,000).
• The contribution doesn’t need to come from the child’s earnings. While the child or grandchild must report earnings on a federal tax return to be eligible for a Roth, the actual contribution can come from gifts from parents, grandparents, and any other family or friends looking to give a young person a fantastic financial head start.

Now let’s talk strategy.

• Offer an enticing carrot to get their attention. Okay, as I noted earlier, it’s a justifiably hard sell to suggest someone very young focus on retirement. So that’s where family and friends with the means to help can pitch in with a matching contribution. For example, maybe you offer to match every dollar they agree to contribute with $2 or more of your own. Up to you to decide how you want to frame your match. Just remember, the total they can contribute to their Roth IRA can’t exceed their earnings for the 2024 tax year.?
• Make it personal with a quick lesson in the magic of compound growth. Make it clear that the reason you hope they will consider opening a Roth IRA is that right now, they have a short window to take advantage of the true secret sauce of investing: time.?
• Explain that the more time their money has to compound, the more money they will eventually have.??And being a teen or young adult is when you can take full advantage of time. That’s not something 30, 40 and 50-somethings can leverage.

Here's one way to frame the conversation:

• $1,000 invested at age 15 that grows at a 6% annualized rate of return will be worth more than $18,000 in 50 years.
• Invest $1,000?a year from age 15 to age 65 earning 6% annualized will net them more than $325,000.
• Then slide in the cost of waiting: Wait until age 35 to start investing $1,000 a year will net them less than $90,000. To end up with the same $$325,000 at age 65 would require contributing more than $3,500 a year if they start at age 35. Make sure they understand that tradeoff: by waiting to save, they end up needing to save more than 3x as much.

There are free online calculators they can play with to see how an early jump on compound growth is a huge financial win (search for “compound growth calculator”). I chose a 6% annualized rate of return for my examples. That’s a somewhat conservative estimate of a long-term average rate of return over decades for someone who mixes stocks and bonds. If they want to get an estimate of an all-stock investment, you can suggest plugging in 10%, which is indeed the long-term historical annualized return for U.S. stocks.

If they are game, and at least 18 they can typically open their own Roth IRA at any discount brokerage. Younger savers will likely need an adult to help them set up a custodial account. It’s an easy process that can be a huge jump start on their future financial security.

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