As summer jobs end and kids head back to school, there's still one important financial task to tackle: convincing your sons and daughters to squirrel away some of their summer earnings in an IRA. Sure, persuading high school and college students to lock up their cash for 50 years or so is a tough assignment. So let the example of Andrea Anderson, 15, and her 13-year-old brother, A.J., help. Each of the Toms River, N.J., teens already has a Roth IRA and a pretty good idea about the power of long-term compounding in a tax-free environment.Take Andrea's account, which she opened thanks to $300 in babysitting earnings. It's invested in the Homestead Value fund, which has rewarded shareholders with an average annual return of 11.9% since it opened in November 1990. If it keeps up that torrid pace for the 50 years until Andrea turns 65, her original $300 would grow to more than $82,000.
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Now, imagine that Andrea socks away $300 a year every year between now and the time she graduates from college at age 22. (She's already added $50 for 2004, based on money earned playing in a string quartet for her high school's senior prom this spring.) That would put a total of $2,400 of her money into the account. Assuming no additional contributions -- ever -- the IRA would grow to $513,000 by the time she is 65.
That's the power of tax-free compounding -- the magic of letting money making money do the heavy lifting in a zero-gravity environment. There's no guarantee that Homestead Value will continue to perform so well. (But the $2,400 in our example would grow to a not-so-shabby $112,000 even if the average return fell to 8%.) And it is pretty much guaranteed that inflation will severely erode the purchasing power of the dollar over the next 50 years. Still, there's no denying the power of the IRA.
But how do you convince your kids, especially if they've already spent every dime they made this summer? Take a cue from Andrea and A.J.'s dad, Ken Anderson. He is such a believer that he put up the money for his kids' accounts. "It's so important to get an early start," he says. "The earlier, the better." He steered Andrea and A.J. to the Homestead fund because of its terrific record and because it has a low, $200 minimum for IRAs.
Ken, a municipal building inspector, also leads by example. He puts the maximum $3,000 a year into his own Roth IRA and kicks in another $3,000 to a spousal IRA for his wife, Dawn.
The Rules of the Roth
You're never too young to have an IRA. As soon as a young person has earnings from a job -- be it babysitting, bagging groceries, lawn mowing or retail -- he or she can contribute to an IRA. Except for the paying gig as a violinist, Andrea mostly makes her money babysitting, earning about $20 a pop for an evening's work. A.J. mows lawns and does other yard work in and around the neighborhood in the summer and shovels snow in the winter.
As Ken and most other parents know, saving for retirement is rarely at the top of a teenager's how-to-spend-my-money list. But the child's own money does not have to go into the account. The cash can come from a parent or grandparent, as long as the teen made at least as much from a job (investment income does not count). The government doesn't really care whose money goes into the IRA.
With traditional IRAs, contributions can be deductible, but withdrawals in retirement are fully taxed. With Roth IRAs, there's no deduction going in, but there's no tax when the money comes out. A tax deduction would do youngsters little, if any, good, so the Roth is an easy choice. The dollar limit on annual deposits is $3,000 for 2004 or 100% of earned income, whichever is less.
We had heard about annuities and were investigating them for our IRAs. We also heard bad things about pushy brokers over the years. So when we went to the ImmediateAnnuities.com site we were skeptical about calling them. But whenever we called their staff was really friendly. They answered all our questions and one of their reps even told us that at our ages there was no advantage to buying the annuity with our IRAs. These guys are really honest!
You don't have to fully fund your children's IRAs to encourage them to get a head start on retirement savings. Some parents issue a challenge, offering to match IRA contributions dollar for dollar. If your daughter is willing to contribute $1,500 of her summer earnings, for example, you could kick in $1,500 too -- as long as the total going into the account does not exceed her total earnings for the year.
Find a Willing Sponsor
Once you persuade your kids of the wisdom of an IRA, the biggest challenge is finding a bank, brokerage firm or mutual fund company willing to take your children's money. The Andersons had no problem with the Homestead funds. But when Kiplinger's surveyed financial institutions to see if they would set up IRAs for minors, some of the telephone representatives told us "That's illegal" or "I never heard of such a thing."
IRAs for kids are not illegal, and if a phone rep seems mystified, ask him or her to check further. Some sponsors have reservations about opening retirement accounts for kids because minors can't legally enter into binding contracts. But a growing number of mutual fund families and many big brokerage firms are willing to open IRAs for kids -- although some require an adult to co-sign the paperwork.
Brian Mattes, a spokesman for kid-IRA-friendly Vanguard, calls a kid IRA "one of the best things you can do for your child. If your child has earned income, absolutely, open one."