Q: My son is 15 years old. Is he qualified to invest in a traditional IRA or a Roth? — Dario
A: As long as he has earned income, your son is indeed qualified to invest in a traditional individual retirement account or a Roth IRA, says Bill Dix, a certified financial planner with Fortune Management in Raleigh, N.C. “It’s actually a great opportunity and with little, if any, downside,” he says.
The benefits of saving early are magnified for people who start this young. Thanks to the power of compounding, even at a modest return, every dollar your son saves between ages 15 and 60 can earn more than twice as much as every dollar he saves between age 30 and 60.
The question is, should he utilize a Roth or a traditional IRA?
Unless he’s in an atypically high tax bracket, the best bet for someone that young is almost certainly a Roth. He’ll pay the taxes today — at what is likely a very low tax rate — but future gains and withdrawals aren’t taxed.
“He’s probably at the lowest rate he’ll ever be in,” says Dix. “A Roth IRA is the way to go.”
Another perk of going with a Roth: Your child can withdraw contributions at any point without running into early-withdrawal penalties. That’s a nice option to have should he want to tap his savings for, say, college. And speaking of college, savings tucked into a Roth, even if it’s in the child’s name, won’t affect financial aid eligibility until he makes withdrawals.
Of course, there are some rules you need to keep in mind.
For starters, earned income includes wages, tips and self-employment income, though he’ll need to do be able to document any income. Also, his annual contributions can’t exceed his annual earnings, and the usual rules that apply to adults also apply to kids.
That is to say, the maximum contribution is $5,500, and if your kid’s adjusted gross income happens to be in the six figures (if only!) his Roth IRA eligibility will phase out between $116,000 and $131,000.
One last caveat: Because your son is a minor, you’ll need to open the IRA or Roth IRA on his behalf in a custodial account. The larger firms, including Vanguard and Fidelity have kits and forms geared toward Roth IRAs for kids, but opening such an account will likely require some additional paperwork and maybe a phone call.
Time well spent to help your kid to put his hard-earned money to work for the long haul.