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Summer Jobs Can Provide Great Savings Lessons

August 14, 2017
Judith Ward, CFP®, Senior Financial Planner
If your teen has earned income through a part-time job, starting an individual retirement account (IRA) can help teach them about savings and investing goals.

Key Points

  • Given the tax bracket most teens are in and the length of time they have to invest, a Roth IRA may provide the most long-term financial gain.
  • Contribution amounts are the lesser of your teen’s earned income or $5,500 to a Roth IRA in 2017.
  • Contributions in a Roth IRA can be taken out at any time tax-free. Withdrawals of earnings can be made penalty-free in some circumstances prior to age 59½.
  • Parents can set up an incentive program to help their teen save by matching contributions.

Summer jobs are more than just a rite of passage for teenagers. They are an opportunity to learn valuable lessons about saving and investing.

Whether your teen is babysitting, lifeguarding, flipping burgers, or delivering pizzas, she can get a head start with her savings and learn financial behaviors that could significantly shape her financial future.

You may think it’s premature to preach to a teen about saving for retirement, but tracking her progress can be an exciting financial lesson.

Consider a Roth IRA

If she has earned income, starting an individual retirement account (IRA) for your teen is a great way to build financial skills and decision-making abilities around money. Given the tax bracket most teens are in and the length of time they have to invest, a Roth IRA may provide the most long-term financial gain.

An additional benefit of a Roth IRA is the flexibility it provides. Not touching the account until retirement or beyond is ideal, but your teen can access the funds in the account should she need to later in life. Contributions in a Roth IRA can be taken out at any time tax-free. And withdrawals of earnings can be made penalty-free in some circumstances prior to age 59½.*

A little can go a long way

To illustrate how even a small annual contribution starting in someone’s teen years could pay off over the long term, the chart below shows an example of how investing $2,000 each year with an annual rate of return of 7% would add up over the course of 10 and 20 years.

Incentivize saving

Chances are your teen might not be enthusiastic about putting her hard-earned dollars from a summer job into a retirement account she probably won’t touch for half a century. As a parent, this is where you can help the most. Set up an incentive program to help your teen save, whether you match 50 cents or $5 for each dollar your teen contributes. Or, you can simply fund the account in total up to the allowable amount. That way, your teen can experience the value of saving for a financial goal without contributing a large portion of what she’s earned.

What’s allowable?

Contribution amounts are the lesser of your teen’s earned income or $5,500 to a Roth IRA in 2017. For example, if your teen earned $6,000 over the summer, contributions would be limited to a maximum of $5,500. Conversely, if she earned $2,000, contributions would be limited to $2,000. Keep in mind that while the Internal Revenue Service does not impose a minimum age requirement to open a Roth IRA, some financial institutions do. There may also be account minimums to consider. Be sure to check before opening an account for your teenager.

What about financial aid?

If you are concerned that a Roth IRA could affect your teen’s financial aid eligibility for college, know that Roth IRAs are not currently a factor in the federal financial aid formula. While universities offering nonfederal financial aid can apply their own requirements regarding Roth IRAs, only some private universities consider these assets in relation to tuition assistance. However, if withdrawals from the Roth IRA are used to pay for college, that income amount will be considered in a future year’s eligibility process and could have an impact.

Saving toward success

While it may seem like you are indulging your teen by giving her the money to help fund a Roth IRA, consider the opportunity this creates to teach her about investing and goal planning.

Involve her in every step along the way, from researching investment options and opening the account to tracking progress and performance. Introduce her to the world of investing. When she is able, she can carry on with her own contributions and continue to become more comfortable with planning and budgeting for savings goals.

Laying the foundation for your teen to be a disciplined, consistent investor can set her on the path to financial success. That kind of investment is one that has returns for a lifetime.

*Withdrawals of earnings from Roth IRAs can be made penalty-free if the account has been open for five years or more and you are age 591/2 or the money is used for exceptions such as qualified higher education expenses, a first-time home payment up to lifetime limit of $10,000, certain unreimbursed medical expenses, and other situations.

This material has been prepared by T. Rowe Price for general and educational purposes only. This material does not provide fiduciary recommendations concerning investments or investment management. T. Rowe Price, its affiliates, and its associates do not provide legal or tax advice. Any tax-related discussion contained in this material including any attachments/links, is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding any tax penalties or (ii) promoting, marketing, or recommending to any other party any transaction or matter addressed herein. Please consult your independent legal counsel and/or professional tax advisor regarding any legal or tax issues raised in this material.

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