When teenagers earn money for the first time, there are so many things they can do with it. It's rare, however, that families consider the possibility of giving a child a running start on retirement savings.
It's a shame, too. That's because the boost that comes from opening a retirement savings account as a teen instead of a few years after college can lead to hundreds of thousands of extra dollars after a half-century of growth.
Most of us have seen basic compound interest graphs before, so we know how the math works for grownups who start setting money aside from their first full-time paycheck. But beginning even earlier supercharges the savings for families that can afford it — or who reel in grandparents and others willing to match a child's contributions.
The process starts with a Roth individual retirement account, and it will need to be a custodial account, with an adult co-signing, if the teenager is under 18. The nice thing about Roths is that you generally pay no taxes on the withdrawals. So the money will grow for many decades and then come out tax-free as long as the rules don't change.
If you're trying to persuade children or grandchildren to save rather than ordering them to do so, you could start with some simple numbers. If you take $5,000 in savings from a few summer jobs and put it in a Roth at age 19, it will grow to $52,006 by the time you're 67 if it grows at a 5 percent annual rate. Wait until 25 to start with that same $5,000, and the balance at age 67 is just $38,808.
Things get more interesting if you pledge that once a Roth is open, you'll spend a few years helping a young adult max out the $5,500 contribution each year as long as that person earns the $5,500 necessary to make a deposit of that size. If that 19-year-old starts with $5,000 and makes the maximum contribution each year until 67, the ending balance is $1,164,985 if it grows 5 percent annually. That's over $330,000 more than what he would end up with if he waited just six years, until age 25, to start the Roth and then saved the same amount.
Some families do seem to be catching on to these possibilities. At Charles Schwab, 87 percent of all custodial accounts are Roths. According to Fidelity, the number of Roth IRA accounts there owned by people under 20 increased 22 percent from the second quarter of 2013 to the second quarter of 2014.
Some parents may worry about the financial aid implications, given that colleges generally want families to turn over a large chunk of student assets each year. The good news here is that when you're filling out the FAFSA form to determine eligibility for various forms of federal financial aid, a student's Roth or other retirement account is not part of the calculation.