Retirement is probably not on most teen’s radars, but it should be. That’s because a relatively small investment today can grow into a a much larger sum later, after decades of compounding. A great place to start is with a Roth IRA.

Key Takeaways

  • A Roth IRA can set teenagers up for a comfortable financial future.
  • Anyone with earned income can contribute to a Roth IRA.
  • Children under the age of 18 need a custodial Roth IRA.

Tax-Free Growth and Income for Retirement

One of the biggest perks of a Roth IRA is the tax break it offers. With a Roth IRA, you don’t get an upfront tax break like you do with a traditional IRA. Instead, your contributions and earnings grow tax-free forever.

This usually works out well for teens. That’s because most teens pay little if any income tax. If you have a summer job, or working during the school year, your pay makes you eligible for a Roth. Here's how it works:

  • Any Roth IRA contributions you make now aren’t deductible, but the deduction wouldn’t be that valuable anyway. And later, when you’re in a higher tax bracket, you won’t have to pay any taxes on that money.
  • You can withdraw your contributions at any time, for any reason, without owing any taxes or penalties. But you need to wait until you’re at least age 59½ to take out the money your contributions earn in interest if you want to avoid a 10% early withdrawal penalty.

You Can Only Contribute Earned Income

Anyone can contribute to a Roth IRA, regardless of age. That includes babies, teenagers, and great-grandparents. You just need to have earned income for the year you make the contribution.

You get earned income when you work for someone else who pays you, or when you own a business or farm. While babies are unlikely to have earned income unless they are child models or actors, the kinds of work teenagers often do—babysitting, lifeguarding, burger flipping, and so forth—will qualify. Investment income doesn't qualify.

The contribution limits on IRAs change periodically, based on inflation. For 2019 and 2020, workers can contribute up to $6,000 a year to a Roth IRA (it's $7,000 for those 50 or older). But your contribution can only be as large as your earned income. If you earned $4,000 during the year, that’s the most you can contribute.

The pay you receive must be legitimate and at the going market rate. Parents, for example, can’t pay their kids $1,000 an hour to mow the lawn and call it earned income. Ideally, you’ll get a W-2 to substantiate your earnings. Otherwise, it’s a good idea to keep excellent records from odd jobs that don’t provide a W-2.

Adults Can Contribute to a Teen’s Roth IRA

Parents and other adults can “match” a teen’s earnings and make a contribution themselves. For example, if you earn $3,000 at a summer job, your parents can kick in the $3,000 contribution and let you spend (or save) your money. Or they could help by contributing a percentage of your earnings—say, 50%.

Parents can contribute the money to your Roth IRA as long as you earned at least that much.

The Internal Revenue Service (IRS) doesn’t care who makes the contribution. You just need enough earned income to equal (or exceed) the contribution.

How to Open a Roth IRA for a Teen

An adult has to open a custodial Roth IRA account for you if you’re a minor. In most states, that’s age 18, but it’s age 19 or 21 in others.

Custodial Roth IRAs are basically the same as standard Roth IRAs, but the minimum investment amount may be lower. Many, but not all, brokers offer custodial Roth IRA accounts. Firms that currently offer accounts for minors include Charles Schwab, E*Trade, Fidelity, Merrill Edge, TD Ameritrade, and Vanguard.

As the custodian, the adult controls the assets in the Roth IRA until you reach the age of majority. At that point, the account belongs to you. You can continue to invest in your Roth IRA and set yourself up for a sound financial future—as far off as that future might seem.