My son just started his first part-time job. Can he open an IRA?
There are two types of IRAs – the Roth IRA and the traditional tax deductible IRA. The basic difference is that contributions to Roth IRAs are not tax deductible, but you can withdraw your savings in retirement tax-free. With traditional IRAs, you can deduct your contributions in the years you make them, but when you make withdrawals in retirement, the money will be taxed at your regular income tax rate.
The better option for young people earning part-time incomes is likely going to be the Roth. That’s because:
- Young workers are probably in the lowest tax bracket and would likely pay a higher tax rate later in life.
- The future taxes they would pay on their earnings – after 40 or 50 years’ of growth – is going to be more significant than any tax break they’d get today.
Opening an IRA is also a great opportunity to talk to your son about the time value of saving. That is, the sooner you start saving, the easier it is to reach your goals.
Use the Compound Interest Calculator on the SEC’s website, Investor.gov, to run different saving and retirement goal scenarios to illustrate this point. Start with a fixed goal, like $1 million. Then show him how much he’d have to save each month if he starts at 22. Next see how much he’d have to save each month if he started at 42.
You can learn more about IRAs, their rules and limits in IRS Publication 590, Individual Retirement Arrangements.
For more money activities for your child, visit our Money As You Grow section.