There are few absolutes in investing, but one thing that should be on everyone’s mind is the idea of funding a Roth IRA. Today we’ll focus on the importance of Roths for young people, and a decision I made for my children that might be overly generous but hopefully meaningful and impactful in the long run.
The primary requirement to contribute to a Roth is earned income, so if you get a W-2 from a job of any sort, you should qualify. This means that even a teenager working their first job can fund a Roth. Of course, the problem is that a teenager working their first job likely has many things on their radar, none of which is retirement, so a teen maxing out their IRA is probably not too common.
But it should be! A 15-year-old putting $6,000 to work in a Roth IRA and never investing again would see it grow to $774,000 by age 65, assuming a 10 percent annualized return. That kind of nominal return is optimistic but probably not impossible in the coming decades, especially if inflation remains somewhat elevated. For comparison, an investor who starts investing $6,000 a year at age 40 (around the time most people start thinking seriously about retirement) enjoys the same 10 percent annualized return and continues to contribute $6,000 every single year until age 65 would not catch up to the 15-year-old’s single $6K investment. The late starter would only have about $720K by age 65 in this hypothetical scenario.
There’s nothing to be afraid of with a Roth IRA — you’re not locking your money away forever. A nice feature (but also a pitfall) of Roth IRA contributions is that they aren’t as permanent as some other retirement elections. Contributions may be withdrawn at any time, without penalty or additional tax to pay. This is a nice feature and might help convince a reluctant investor to move forward, but it also makes it very tempting to rob the cookie jar and use Roth funds for projects or large purchases throughout the working years. You can’t put the contributions back in once they’re out, and the ability to grow Roth contributions and withdraw them later in life tax-free is such a powerful opportunity that early withdrawals should be avoided if at all possible.
To me, the power of a Roth is so compelling that I am planning to match contributions 1:1 for my teenagers as they start working, at least at first. For example, my high-school-aged son will have an internship this summer that should pay about $4,000 in all. I’m going to let him keep the money but gift him an equal amount to fund his Roth IRA with no strings attached (other than making him listen to me ramble on about it frequently and at length!). This might seem overly generous — especially since I’m sure he’ll spend his share on what I would consider frivolous things — but to me it’s worth it to try to hook him on the excitement of watching his investment account rise in value over time. Besides that, this gift will likely make a real impact on his future as he ages — far in excess of anything else I could spend $4,000 on this year. I am optimistic that if it stays invested for his lifetime, it really will turn into a six-figure amount some day in the future.
Parents buy cars for their children all the time, and we all know that cars tend to be depreciating liabilities with no lasting value. Helping younger children maximize their Roth IRA contributions is a meaningful gift that can change the trajectory of their lives later on — and get them in the habit of maxing it out each year.
An investor who contributes $6,000 to their Roth each year from age 15 to 65 and achieves 10 percent annual returns would have over $8 million dollars at age 65, money that can be withdrawn tax-free in retirement. That thought alone should be exciting even to an overstimulated and insouciant 15-year-old most interested in deciding which video game to play next!
Gene Gard is Chief Investment Officer at Telarray, a Memphis-based wealth management firm that helps families navigate investment, tax, estate, and retirement decisions. Ask him your question at ggard@telarrayadvisors.com.
