This retirement account can be 'triple-tax efficient' for teens this summer, advisor says

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If your kids are working summer jobs, it's a prime opportunity to help them open a retirement account and start saving for the future, experts say.

Roth individual retirement accounts can be "triple-tax efficient" for teenagers, according to certified financial planner Carol Fabbri, managing partner of Fair Advisors in Conifer, Colorado.

Roth IRAs are funded with after-tax dollars, but teens often earn less than the standard deduction, which means they won't owe taxes on the income used for contributions. The standard deduction for single filers is $14,600 for 2024.

Plus, Roth IRAs offer tax-free growth on investments, and withdrawals in retirement are generally tax-free, Fabbri explained.

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If a 15-year-old invested $500 this summer, they could have almost $10,000 when they retire in 50 years, assuming a 6% growth rate, Fabbri said.

Of course, the power of long-term compound growth, or returns on your returns, only magnifies the sooner you start saving and investing, experts say.

More than 8 in 10 teenagers are already thinking about retirement, but most mistakenly think savings is the best long-term strategy, according to a recent survey from Junior Achievement and MissionSquare.

How Roth IRAs for kids work

If a child is considered a minor, parents can open a "custodial IRA," which is a retirement account for a minor.

The parent manages the account and investments until their child reaches the age of majority, which is typically 18, but could be 21 in certain states.

While there's no age minimum for Roth IRA contributions, children must have so-called "earned income," or compensation from a job, to qualify.

For 2024, the IRA contribution limit is $7,000, but children can't deposit more than their earned income for the year. You can make 2024 IRA contributions until the tax deadline in 2025.

Another perk of Roth IRAs is flexibility. The account owner can withdraw contributions any time without taxes or penalties — and there are certain exceptions to the 10% penalty on earnings withdrawals before age 59½.

Offer a 'match' to incentivize contributions

"I am a huge fan of kids opening Roth IRAs with summer income," said CFP Tammy Wener, principal of RW Financial Planning in Lincolnshire, Illinois.

Wener's children — a high schooler and a college student — each have a Roth IRA, and she provides a "match" to incentivize contributions.

However, the child's Roth IRA contribution and parent match can't exceed the child's earned income for the year, experts warn. Parents need a "clear paper trail," including income tax returns that report the child's yearly income, Wener said.

The IRS levies a 6% penalty on excess IRA contributions, which you can avoid by withdrawing the extra amount by your federal tax filing deadline.

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