Powerful CompoundingSubmitted by Grunden Financial Advisory, Inc on August 11th, 2014
Your teenager is in the last month of his or her summer job, and chances are the wages have been collecting in a bank account. What should happen with that money when your child goes back to school?
One possibility is to start a custodial Roth Individual Retirement Account, owned by your teenager. All you need is a custodial account with an adult co-signing (if the teen is under 18). That money can grow for many decades and come out tax-free 30 or 50 years down the road.
How much are we talking about? If the money were to grow at an average rate of 5% a year (which, of course, is not guaranteed, but is in line with long-term averages for a balanced portfolio), then a $5,000 contribution at age 19 would grow to $52,006 by age 67. If your child waits until age 25 to invest the same amount in a Roth IRA, under the same return assumptions, the balance at age 67 would be just $38,808.
If that contribution becomes a habit, the numbers become more interesting. A 19-year-old who maxes out on a $5,500 Roth contribution every year until age 67, under the same rate of return assumptions, would see the account grow to $1,164,985.
Suppose your teen decides to spend some of that money, or use it for college tuition? Parents and/or grandparents can match whatever contribution the child decides to make, to bring the total back up to $5,500. They money in a Roth or other retirement account doesn’t count toward the FAFSA financial aid form, so you don’t have to worry about compromising the teen’s financial aid eligibility. And having a hefty Roth IRA at retirement might address the possibility that Social Security won’t be around, or as robust, when your kids eventually retire.