Here’s How to Use Summer Earnings to Jumpstart a Roth IRA
By Sarah Brenner, IRA Technical Expert
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Having a summer job can be a valuable experience for a young person. Whether it is scooping ice cream, lifeguarding, or working as a camp counselor, a summer job can teach life skills and give a first opportunity to manage finances. An important part of managing finances is saving for the future (just like Fund Your Future describes in great detail). Why not make contributing to an IRA part of your child or grandchild’s summer job experience? They will get an early start on retirement savings and also learn the habit of making saving for the future a priority.
You may wonder whether a Traditional or Roth IRA would be the better choice for a young person who is just beginning to save for retirement. For younger people, many experts would say that a Roth IRA is more attractive than a Traditional IRA. Contributions to a Traditional IRA are tax deductible, but few young people will earn enough to benefit from deducting these contributions. Roth IRA contributions are no tax deductible, but offer tax-free earnings if certain rules are followed. By contributing at a young age, your child or grandchild will have the important advantage of time. The earlier funds are contributed to a Roth IRA, the more potential there is for tax-free earnings to accumulate. There is no minimum age for establishing an IRA under the law. Some IRA custodians may have policies restricting IRAs for minors, but many others will allow these accounts to be established.
An IRA contribution must be based on earned income or taxable compensation. Wages from a summer job would be considered taxable compensation. For 2015, the contribution is limited to the lesser of $5,500 or taxable compensation for the year. If your child or grandchild’s summer job earnings are less than $5,500, he or she would be limited to amount they earned. For example, if your daughter or granddaughter earned $2,000 this summer and had no other earnings for the year, she would be limited to contributing $2,000. You are not required to contribute the maximum amount for which you are eligible. Your daughter or granddaughter may decide she only wants to contribute $500. Any amount that is contributed to a Roth IRA is a good start! A parent or grandparent may also want to consider helping make an additional contribution. There is no requirement that the contribution actually be made from the wages earned by the young person. A parent or grandparent could add the remaining $1,500 to the $500 already contributed to make the maximum Roth IRA contribution allowed for the year.
For younger people, retirement may seem a long way away. They may worry that they will need the funds sooner for something else. A Roth IRA alleviates these concerns. Your child or grandchild will be able to take a distribution of tax-year contributions at any time, for any reason, without tax or penalty, if they need access to their funds. If the Roth IRA remains open for five years, he or she will be able to take a tax-and-penalty-free distribution, including earnings, to purchase a first home.
A summer job provides many benefits to a young person. A Roth IRA could be an important one. Jump starting a Roth IRA now with those summer employment wages will enable your child or grandchild to begin saving early and learn valuable lessons about preparing for retirement and the future.
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