“As a parent who oversees the contribution of $2,000 each to IRA accounts for two summer employed college student sons, I urge you to tell everyone to do the same. Or is there some new tax angle that would not make it as prudent as I think it is?”
Yesterday we cured the common cold, but this one may be even better. It won’t help you, but it could sure help your kids if you can afford it. And they don’t have to be college-age, either.
Say you have a 12-year-old earning $100 a week this summer cleaning pools or mowing lawns or teaching Windows 95. Have her set up an IRA with some good low-expense no-load mutual fund and put all the money there.
She will resist this idea strenuously, but there’s a way around that. Increase her allowance by the same $100, so it doesn’t cost her a dime. If she still doesn’t like the idea, you have a mentally challenged kid. (Or, if your powers of persuasion are a little better than that, tell her you’ll chip in $75, so it only costs her $25 in current cash to stash away $100-a-week in her IRA. That should sound pretty good, too, and gives her more of a stake in it.)
No one starts this early. But because “the power of compound interest” over a lifetime is so extraordinary, they should. So long as the money is earned in some legitimate arms-length way (not mowing YOUR lawn or cleaning YOUR pool or teaching YOU Windows 95), your child is entitled to put up to $2,000 of it a year into an IRA.
Clearly, the purpose wouldn’t be to save taxes in the short run. Indeed, there’s always the risk your kid will, irresponsibly, raid the IRA in a few years. That would just serve to transform today’s mostly nontaxable dollars (because on a kid’s meager income little or no tax is due) into taxable dollars (because by then he/she’ll be a taxpayer).
But look how it works if done right:
1. Your kid gets into a working/saving habit. This alone is priceless.
2. Maybe your kid learns a little about investing and capitalism. This can’t hurt, since it’s the foundation of our prosperity.
3. If your kid puts $1,000 a year into an IRA from age 12 through 21 and then stops, and if the mutual fund grows at 10% a year over the kid’s lifetime, then the income from those ten summer jobs — $10,000 — will grow by age 70 (when withdrawals must begin) to $1.7 million. Which would be enough to throw off an annual income of $200,000 for the following 20 years, to age 90. All for having done this at the outset.
Of course, figuring 3% inflation over the same period, $200,000 a year would really be only about $35,000 by then. And that’s pre-tax. But how many 70-year-olds do you know today who wouldn’t be glad for a $35,000 boost to their annual income?
(And because this money would be “locked away” in an IRA, college financial aid offices should not take it into account in determining available funds, which could make a difference in obtaining student aid.)
So, yes: if your kids are working this summer, or a few hours a week during the school year, you might consider something like this. And if they’re not working, maybe they should be.
The IRA can be set up, and 1996 income deposited, any time until next April 15. But better to do it today.