This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here
TheStreet Open House

You're in High School and Starting an IRA

NEW YORK (TheStreet) -- The other day we talked about how a young person can best handle earnings from a summer job, concluding that in today's low-interest world a simple checking account, chosen for convenience rather than interest earnings, would work well for cash likely to be spent within the next few years.

But what if a high school or college student is capable of setting money aside for the long term -- as in saving for retirement?

Thoughts of saving for needs 40, 50 or 60 years in the future can make a teen or 20-something gag. But with the first true "earned income," as opposed to allowance or birthday gifts, comes the opportunity to open an IRA that could produce stupendous gains over such a long investing horizon.

The first objection: The young earner may want to spend the money or save for a more immediate goal, such as buying a car. But generous parents or grandparents (or anyone else, for that matter), can get around that by replacing money the young person contributes to the IRA.

Also see: The New Grads' Guide to 401(k)s

That term "earned income" is important because IRA contributions cannot exceed the amount the plan beneficiary earns from a legitimate job. Parents cannot contribute on the young person's behalf. That's why it's nearly impossible to set up an IRA for an infant.

Earned income, for example, is wages reported on a W-2 form. A W-2 is not necessary, though, if good records are kept. The pay must be at a going rate. Parents, for example, cannot get away with paying their kid $1,000 a week to feed the dog. Investment gains do not count as earned income.

In most states, an IRA for a person under 18, 19 or 21 must be set up as a custodial account managed by an adult. For this year, the maximum contribution allowed is the beneficiary's earned income or $5,500, whichever is less. Most banks, brokerages and mutual fund companies offer custodial IRAs, and many have very low minimums to start an account -- as little as $100 in some cases.

IRAs come in two flavors, traditional and Roth. With a traditional IRA, the account holder may be eligible for a tax deduction on contributions. After that, investment earnings are tax deferred. Income tax on contributions and gains is not due until money is withdrawn, which is generally not before age 59.5.

Also see: 8 Pieces of Advice Grads Will Need for the Rest of Their Lives

With a Roth, there is no deduction on contributions, but all withdrawals, including contributions and investment gains, are tax free.

The Roth, then, is generally the best choice for a young person. The summer job generally pays so little as to leave the young worker in the zero percent tax bracket. That makes the tax deduction on contributions to a traditional IRA worthless. It also makes the lack of a tax deduction on a Roth contribution irrelevant. So the Roth comes out on top due to the tax-free treatment on withdrawals. The investment can compound for decades without a cent ever paid for taxes.

Remember that a single person can have multiple IRAs, and can mix the two types. Later, when income is higher and taxes are a consideration, it might make sense to open a traditional IRA.

How should IRA contributions be invested? Unless the young person, or one of the parents, is an adept investor, the easiest option is a target-date retirement fund. Choose a fund keyed to the year you're likely to retire (or as close as you can get), and the fund company will select an appropriate mix of holdings.

Generally, that will mean mostly stock-owning mutual funds. Over long periods they tend to provide bigger returns than bonds, and with 40 or more years to retirement a young person will have plenty of time to ride out any downturns. As the account holder gets older, some of the holdings will be switched to bonds for an added degree of safety.

Select the service that is right for you!

COMPARE ALL SERVICES
Action Alerts PLUS
Try it NOW

Jim Cramer and Stephanie Link actively manage a real portfolio and reveal their money management tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
  • Weekly roundups
TheStreet Quant Ratings
Try it NOW
Only $49.95/yr

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
  • Upgrade/downgrade alerts
Stocks Under $10
Try it NOW

David Peltier, uncovers low dollar stocks with extraordinary upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
  • Weekly roundups
Dividend Stock Advisor
Try it NOW

Jim Cramer's protege, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Alerts when market news affect the portfolio
  • Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
Real Money Pro
Try it NOW

All of Real Money, plus 15 more of Wall Street's sharpest minds delivering actionable trading ideas, a comprehensive look at the market, and fundamental and technical analysis.

Product Features:
  • Real Money + Doug Kass Plus 15 more Wall Street Pros
  • Intraday commentary & news
  • Ultra-actionable trading ideas
Options Profits
Try it NOW

Our options trading pros provide daily market commentary and over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.

Product Features:
  • 100+ monthly options trading ideas
  • Actionable options commentary & news
  • Real-time trading community
  • Options TV
To begin commenting right away, you can log in below using your Disqus, Facebook, Twitter, OpenID or Yahoo login credentials. Alternatively, you can post a comment as a "guest" just by entering an email address. Your use of the commenting tool is subject to multiple terms of service/use and privacy policies - see here for more details.
Submit an article to us!
DOW 16,375.14 -5.27 -0.03%
S&P 500 1,896.04 +9.28 0.49%
NASDAQ 4,293.4540 +35.0160 0.82%

Brokerage Partners

Rates from Bankrate.com

  • Mortgage
  • Credit Cards
  • Auto

Free Newsletters from TheStreet

My Subscriptions:

After the Bell

Before the Bell

Booyah! Newsletter

Midday Bell

TheStreet Top 10 Stories

Winners & Losers

Register for Newsletters
Top Rated Stocks Top Rated Funds Top Rated ETFs