Six Steps to Open a Roth IRA for a Teen
By Jane Mepham
Last July, I gave you Six reasons why your teen needs a Roth IRA account.
In this post, I’ll outline the six steps I’ve taken to make this a reality for my teen. She worked this past summer and made a good chunk of change. It really doesn’t matter how much your teen makes; the key thing is to get them started and associating earning income as something that’s followed by investing some of that cash.
Jane Mepham
1) Talk with Your Teen About Investing
When your teenager starts working, there are a lot of competing “needs” for that money. It’s probably the most amount of money your teen has had to manage on their own. Hopefully, you’ve been talking to them about the basics of money, saving, investing, etc., so this is just the continuation of the conversation.
Talk to them about how investing works, and especially how compound interest works. There is a reason Albert Einstein called it the “most powerful force in the universe.” This article 10 Reasons why Compounding Interest is the 8th Wonder of the World, is one of the best resources I have read on the subject. The article is an easy read for beginners and teens.
Discuss the possibilities of what the future money can do for them, and to make it even sweeter, use real numbers. This handy compound interest calculator is brilliant for showing them how their money will grow.
For example, a one-time investment of $5,000 at 8% interest rate will grow to $121,366 in 40 years.
If they ask questions on investments, here are a couple of books you can share with them.
2) Learn the Wonders of the Roth IRA Account
Move to explaining the basics and the benefits of the Roth IRA account, especially if they have questions on taxes. (My previous article is a great guide for this.)
3) Choose a Roth IRA Custodian and Open the Account
There are a lot of online options for this. You want a custodian that has the following:
- Low fees, wide investment selection, good customer service, user-friendly website. Examples of this include Vanguard, Fidelity, Charles Schwab, TD Ameritrade, Altruist and many more. Don’t complicate this one, pick one and go. I went with TD Ameritrade, as I already have an advisor relationship with them.
- If your teen is a minor, open a minor Roth IRA. If she is 18 and in some states 19, she can open the account on her own. But it’s still worth guiding her.
4) Fund the Roth IRA
Our combined goal is to keep adding money to this account so we linked her bank account and pulled in the money as a lump sum, once she decided how much she was going to invest. She can invest up to $6,000, but not more than her earned 2021 income. Letting her know she can log in anytime and do the actual transfer gives her some control, which you want with this group.
To sweeten the deal and keep encouraging her, I’m matching her dollar-for-dollar of whatever she puts into the account, this year. So, if she deposits $1000 dollars, I’m going to deposit $1000 dollars into the account. With her depositing $3000, we’ll easily max out her 2021 contribution, which is great!
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5) Start Investing
I’m keeping this as simple as possible, and we’ve agreed I’ll invest about 70%-80% of the money. I get to pick what to invest that money in. She is free to pick the investments for the other 20-30%.
At this point the goal is for her to learn how investing works, using real money after doing some research on her own. We are not concerned about tax implications since this is a Roth account.
We’ve established a few ground rules, but she has a lot of freedom on this portion of the money. She is welcome to compare notes with me and I’m happy to discuss how things are going anytime.
6) File 2021 Taxes
For 2021, the threshold for filing taxes on regular income (W-2) is $12,550 — basically the standard deduction. If they earned below that, it may not be necessary to file taxes but if the employer withheld any taxes, the only way they are going to get that money back is to file. Plus, I think it’s a good teaching opportunity on how taxes work.
Her employer is giving her W-2s so we are going to file her taxes for her.
If the income is from self-employment, like doing odd jobs around the neighborhood, the threshold is a lot lower. They need to file taxes if their income is $400 or more. The beauty of self-employment income is you can start teaching them all about business deductions.
If you end up not filing taxes, be sure to keep meticulous records of their income, in case questions were to ever come up.
About the author: Jane Mepham
Jane Mepham is the founder & principal advisor at Elgon Financial Advisors, a registered investment advisor in the state of Texas.
She enjoys simplifying the complexities of the U.S. financial system for immigrants and foreign-born families, including those on work visas. She loves working with her clients to map out a personal strategy that addresses all areas of their financial lives (budgets, college planning, insurance, retirement, tax-planning, investing, etc.) allowing them to take full advantage of the opportunities available and avoid key financial mistakes that could derail their American dreams.
Two of our Retirement Daily assistant editors opened Roth IRAs and wrote about their experiences. Read Hannah Sammut's here and Sadie Ouillette's here.
