Retirement can be a difficult concept for many adults to understand, let alone children. But starting young can help build returns and teach discipline for a lifetime of savings and investing.
When kids ages 8 to 14 were asked what they would save $100 for, only 5% said they’d save it for retirement, according to a 2022 T. Rowe Price survey. That compared with 79% saying they’d save it for something they want to do or buy later, and 26% who chose saving for college.
One way to help kids start early in retirement savings and learning about investing is to open a custodial Roth Individual Retirement Account for a child.
“It’s a struggle, the concept of delayed gratification. Most kids are not focused on retirement. But this is less about retirement and more about investing and learning,” said Rita Assaf, vice president of retirement and college at Fidelity Investments.
Custodial Roth IRAs allow the adult to maintain control over the account, but the child remains the beneficial account owner and the funds in the account must be used for the benefit of the minor. When the minor reaches a certain required age, typically 18 or 21 in most states, the assets must be transferred to a new account in their name.
“Getting exposure to the idea of savings, to the idea of budgeting, to investing and learning what can happen over time is important,” Assaf said. “We see a gap – it’s not taught in school. How do we get children engaged and invested so they can learn earlier about money and savings?”
Although 39% of children have a savings account, only 6% have an investment account where they hold stocks, mutual funds or ETFs, according to the T. Rowe Price 14th Annual Parents, Kids & Money survey.
To contribute funds to the Roth IRA, the child must earn the money. Kids don’t need a W-2. The income can be from cash earnings from babysitting or mowing lawns. Just maintain good records on your own to keep track of the earnings.
“It’s challenging trying to convince the child to turn over hard-earned cash for a delayed goal,” Assaf said. “But starting early makes a big difference over a lifetime.”
If a child made the maximum Roth IRA contributions each year starting at age 15, they could amass as much as $3.1 million by age 70. Meanwhile, if someone started at 45 and made the maximum annual contributions, they would only have about $450,000 by 70, according to Fidelity Investments.
Of course, there’s rules and fine print to understand.
There’s an annual maximum contribution of $6,000 in 2022. Contributions are made with after-tax dollars. The minor must be under the age of 18 or 21, depending on the state’s age of maturity.
The contributions to a Roth account can be withdrawn at any time. But the earnings on that money can only be withdrawn as rules permit. Earnings can be taken out without paying taxes after the account owner reaches age 59½, or due to disability or death. Also, the account owner must have had a Roth IRA open for at least five years.
However, the rules allow for a federal tax- and penalty-free withdrawal of up to $10,000 in earnings, even if the investor has not reached age 59½, as long as the money is used for a first-time home purchase and the 5-year rule has been satisfied. The funds also may be used for most college and higher-education expenses.
Banks, credit unions and investment firms that offer traditional IRAs and Roth IRAs generally offer custodial Roth accounts. You can open accounts often by downloading an application or applying in person.
Still, custodial Roth IRAs should be part of an overall plan for the child, rather than the first step.
Roger Young, thought leadership director at T. Rowe Price, said it’s important to start with savings before you talk about investing.
“Don’t let your zeal for investing get ahead of yourself as a parent,” Young said.
About 53% of Americans haven’t opened any financial accounts for their kids, according to a 2020 survey by CNBC and Acorns. And 57% of parents have at least some reluctance to discuss money matters with their kids, T. Rowe Price found.
“You want savings you can get to before you’re into long-term investments you can’t access. For things like saving for a car, or video games or spending money for college – all that is appropropriate for a savings account,” Young said.
“You have to start with the concept of saving. Having that delay – to get something you want that’s nicer and better later,” Young said. “Then you can get into concepts like investing and returns and how to understand compounding.”
Young said there are different ways to talk to kids about retirement.
“Retirement may be a foreign concept for them, but they may have grandparents who are alive that they can see who had to save and invest in order to retire,” Young said.
“There’s also the idea of financial independence. Not needing to hold on to a job because you have the financial freedom and security to be independent. That’s an idea that might resonate with some kids – being financially independent,” Young said. “Parents who have regular conversations about money have kids with greater success with money.”
The popularity and news headlines about cryptocurrency and meme stocks makes many kids more aware of investing, but they need to be taught about the risks, he said.
“The idea of cryptocurrencies and meme stocks – kids are definitely into those topics, which can spark positive conversations about money. The downside is not enough parents are having conversations about the risks of those investments,” Young said.
If kids were given $100: 49% of them said they would save it; 29% would invest it; and 23% would spend it. Among those who would invest it, 57% said they would invest it in cryptocurrency compared with 38% who said they would invest it in traditional stocks, the T. Rowe Price survey found.
“It’s about learning healthy habits,” Assaf said. Start by having a conversation and bringing up financial topics. What’s the purpose of money? How do you save? How do you budget? How do you make your money grow?”
“How do you get kids to save for retirement when it’s many decades away? Putting a little aside can make a big difference. Starting much earlier can allow small dollars to grow over time,” Assaf said.
This article was originally published in Barron’s on September 28, 2022, and written by Jessica Hall.
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