Thank You Pam Cunningham, Financial Advisor with Marino, Stram & Associates, LLC for your contributing educational article!
Helping Children Save for the Long-term
In our last newsletter Attorney Lee Darst offered excellent ideas on how to protect your children at college with s few important estate documents. Her ideas brought to mind the importance of helping children and grandchildren learn the value of saving money for the long-term. During this graduation season you may want to help Jack and Jill get started.
When we think about saving for retirement most of us think about using IRAs and other retirement accounts during our working years. But did you know that children who earn money from summer jobs or part time jobs during their school years, or after college are eligible to start saving for retirement with IRAs? As long as a child has "earned income", defined as wages, salaries, tips and other taxable employee pay, they are eligible to contribute up to their taxable earnings but not to exceed the IRS limit of $5,500 in 2017. And you can make a contribution to a Roth IRA on their behalf to help get them started.
What is an IRA?
It's an Individual Retirement Account that enables workers to accumulate retirement assets on a tax deferred basis. Tax deferred does not mean tax free. Deferral means you don't pay taxes on the savings until you withdraw money from the IRA later, preferably many years later. The primary advantage to contributing to a traditional IRA is that contribute pre-tax dollars that are deductible from your income in the year of the contribution. Withdrawals are fully taxable and you will pay a penalty for withdrawals prior to age 59 ½.
What is a Roth IRA?
Most of us are familiar with a traditional IRA described above. The Taxpayer Relief Act of 1997 established the Roth IRA. You contribute after tax dollars, meaning you cannot deduct the contribution from your income in the year you make the contribution. The key advantage to a Roth account is that the earnings on your investment - in the form of interest, dividends or capital gains - are tax deferred and tax free when you withdraw money later. Basically the IRS is saying "thank you" for paying taxes on the contributions up front and in return for that we'll allow you to accumulate additional contributions and growth tax free.
Another advantage to a Roth IRA is that contributions are available for withdrawal without any tax consequences because they were after tax contributions. However, earnings on contributions may be taxable unless held until age 59 ½.
Let's get back to Jack and Jill. If Jack makes $2,500 at his summer job, he may contribute up to $2,500 to an IRA or a Roth IRA. If Jill makes $7,500 during her summer job, she may contribute up to $5,500 to an IRA or a Roth IRA. If the child is under the age of 18 (age of majority differs by state), he/she cannot hold the account in his/her name, but you may open a custodial account in your name with Jack or Jill as the beneficiary. At age 18 it is advisable to convert the account into Jack's or Jill's name. If the child is 18 or older you may help him/her open an IRA in his/her own name. In either case, the child may make contributions to the account and so can you, as long as the total does not exceed the maximum IRS limit of $5,500 per year. (Note: If you are age 50 or older you may contribute up to $6,500 to your own IRA or Roth IRA this year.)
So what does this mean for Jack and Jill? You can help them understand the value of saving money for the long term.
- Suggest that if they contribute a portion of their earnings - say $100 per month - into a Roth account, you'll match it or, even better, you'll contribute the balance to max out the contribution for the year.
- Teach them to understand the time value of compounded interest and earnings. Let their first long-term savings experience with an IRA or Roth IRA serve as a transition to starting a 401k retirement savings plan when they begin working for an employer that offers such a plan.
- Show them a simple calculation such as this one - if you contribute $458 every month ($5,500 annually) into an IRA or Roth IRA, invested in a moderate risk portfolio that earns 5% per year, your IRA after 20 years will be worth $188,253.
Long-term savings for retirement using a tax deferred IRA or Roth IRA may comprise a piece of your retirement nest egg. For more information on how to get started, contact a Certified Financial Planning™ Practitioner.
(Note, there are many rules associated with contributions to and withdrawals from IRAs and Roth IRAs, too numerous to discuss in this article, including taxation, withdrawals for certain exempt uses, and income limits. For more detail, be sure to speak with a qualified Financial Advisor or tax professional.)
Pam Cunningham, MBA, CFP®
Financial Advisor - Senior Associate
25 Braintree Hill Park, Suite 205
Braintree, MA 02184-8731
Advisory, financial planning and asset management services offered through Marino, Stram & Associates,
LLC. Pamela J. Cunningham, Financial Advisors. Securities offered through Securities America, Inc. Member FINRA/SIPC. Pamela J. Cunningham, Registered Representative. Marino, Stram & Associates, LLC and Securities America, Inc. are unaffiliated.