IRAs for Kids
Unless your child becomes an Internet mogul or hits the lottery, he probably won't earn a million dollars in one lump sum. Still, he can amass this kind of fortune with very little effort. The keys to becoming a millionaire are starting young and enjoying the magic of compounding.
Getting your child to start thinking about retirement before he's even out of school can produce several benefits.
Watch Your Step
Check out the treatment of IRAs under your state income tax law (if you have one). Most states allow for the same treatment as on the federal tax return, but some have different rules.
Watch Your Step
Before you get carried away with the size of the fortune your child can have in retirement, don't forget to factor in how much it will really be worth at that time. Inflation will eat into the buying power of his retirement dollars.
- He'll start to appreciate the need to think about the subject, something that many grown-ups put off until retirement is already upon them. He'll be able to learn about different ways to save for retirement, using tax-advantaged savings vehicles and other methods to build up a retirement fund.
- He'll start to learn about tax-favored ways to save for retirement. My teenagers started their IRAs the year they received their first W-2 form. The process of opening the account—they had to sign the papers—led to an explanation of what IRAs are all about and how they'll benefit from their contributions.
- He'll have less pressure to save for retirement if he starts doing it early. For example, if he wants to have $1 million by age 65 and he starts saving at 15, he has to put in only $56.33 each month (assuming an annual return of 10 percent). If he doesn't start saving for this fund until he's 30, he'll have to save $258.49 each month. If he delays until he's 50, the monthly savings amount climbs to $2,383.83.
As long as your child is working—even part-time—he's in a position to start his retirement fund. The best way to do this on a tax-advantaged basis is by contributing to an IRA. An IRA, which is short for individual retirement arrangement or account, is a creature of federal tax law.
By starting young, your child has a longer time to save for retirement. This can mean that your child must save less to reach the same savings goal than someone who starts later in life. This also can mean a greater savings fund by retirement age.
If your child starts contributing to an IRA at the age of 18 and puts in the full $2,000 limit each year until he's 27, he'll have a $1 million by the time he's 67 without adding another penny. This example assumes an annual return of just 9 percent. Think what can be accumulated by retirement if he can get 15 percent or even 20 percent on his money each year (the S&P 500 has returned more than 20 percent for the past four years).
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Excerpted from The Complete Idiot's Guide to Money-Smart Kids © 1999 by Barbara Weltman. All rights reserved including the right of reproduction in whole or in part in any form. Used by arrangement with Alpha Books, a member of Penguin Group (USA) Inc.
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