Raising Financially Savvy Kids: How to Begin Their Retirement Savings

Parents aiming to instill strong financial habits and ensure their children’s prosperous retirement often seek effective strategies. By initiating contributions to a Roth IRA on behalf of their kids, parents not only cultivate early retirement savings but also impart the significance of consistent saving from an early age.

A recommended approach to provide youngsters with a substantial boost in their retirement savings is to fund a Roth IRA. Many parents adopt comprehensive plans because they wish they had started saving earlier in life. Fearing that their children might replicate the same financial oversights, parents endeavor to educate them about financial management.

The paramount lesson here is the importance of savings, which is often underestimated. To ensure an annual income of $40,000 in retirement, assuming a 4% sustainable withdrawal rate, accumulating $1 million by retirement is crucial. While this target may seem daunting, particularly for young individuals, their advantage lies in time. Commencing savings and investments at a younger age translates to greater wealth accumulation due to the extended period of growth.

Realistically speaking, teenagers seldom contemplate retirement. However, a straightforward tactic accessible to parents is to facilitate funding of a Roth IRA for their children. Suppose a teenager earns $3,000 through employment in 2024. If the income is categorized as W-2, the teenager can allocate 100% of the earned income, up to $6,500, toward a Roth IRA—equivalent to $3,000. Should the income be 1099, the contribution ceiling decreases by 7.65% (half of the self-employment tax), amounting to $229.50, and allows a contribution of $2,770.50 to the Roth IRA.

Despite the likelihood that adolescents lack the resources for self-contribution, parents can step in by providing a tax-free monetary gift (up to $17,000 per individual in 2024). This gift can then be used to fund the Roth IRA. In most jurisdictions, if the child is a minor, the initial step would involve a minor Roth IRA with the parent as the account custodian. Subsequently, once the child attains legal adulthood, the account can be converted to a regular Roth IRA under the child’s ownership.

What kind of impact can this exert on the children’s financial prospects? Assuming annual contributions of $3,000 during high school junior and senior years, coupled with $6,000 annually over four college years (totaling $30,000 in parental contributions), substantial outcomes can be anticipated. Calculating with a 6.8% annual return from ages 16 to 40 (portfolio consisting of 80% stock), 6.4% from ages 41 to 60 (portfolio consisting of 70% stock), and 6.1% post-age 60 (portfolio 60% stock allocations), the child could potentially have tax-free retirement savings exceeding $600,000 by age 65. This fund has the potential to yield over $21,000 as sustainable tax-free income (withdrawing 4% annually) throughout retirement.

This endeavor also provides an educational opportunity to introduce the children to fundamental investment concepts, such as the nature of retirement accounts and the significance of the time value of money. Ideally, the introduction to regular contributions will foster enduring financial discipline well into their adult lives—a legacy worthy of parental pride.