The magic of compound interest is pretty amazing. And it’s something I wish I had known about sooner.
I didn’t have much of a financial education as a kid. In my twenties, I felt like I was behind and knew less than my peers about how to manage money. So, I read all the books, all the blogs, and even went to some continuing education classes. Getting a handle on my finances in my early 20s was literally life-changing. My husband and I have built the kind of financial comfort zone that I really couldn’t have imagined as a kid. I want my kids to have that feeling of financial security as adults, too. For me, helping them achieve that starts with educating them about money and having them play an active part in money management.
When my kids got old enough to start earning some income, I wanted to teach them about how to invest their money. The first thing I thought of was getting them started on retirement savings. I know – that probably sounds crazy. But, when you play with a compound interest calculator, you’ll see that just a little bit invested now can mean something huge later.
For example, if my 16-year-old puts $100 in a Roth IRA this year, in 50 years, with an average rate of return, that $100 will be about $11,750. If he puts in just another $100 each year through that same timeframe, his $100 per year turns into just about $125,000, even though his total cash investment is only $5,000. Thank you, compound interest!
Over the last few years since my kids began earning money, I’ve sat down with each of them individually to show them what’s possible with just a small investment using a compound interest calculator like this one. After seeing the potential, all three of them have been excited to put in a little of the money they earn and see what happens.
They each chose their own funds to invest in. It was interesting to see them consider fund performance, environmental sustainability, American-only, or global funds. They had opinions – and not always the same opinions as their siblings or me. Now that they’ve got their investments started, every now and then, we’ll log in to their accounts to see how the stock market has made their money grow, sometimes shrink, and then grow again over time. Sometimes they’ll ask me to add funds from their bank account, but, of course, most of the time, we just ignore their Roth IRA. When we’re operating in such a long time horizon, a “set it and forget it” style of investing works great. Teaching kids about saving and investing doesn’t have to be hard!
The investment tool we use is a Custodial Roth IRA, or what is sometimes called a Roth IRA for Kids.
Facts about the Roth IRA for Kids
- Tax Benefits: The funds are tax-advantaged just like a regular Roth IRA that you might have. You contribute post-tax income, and your child won’t be taxed on the income in retirement
- Minimum Deposit: There is no minimum. You can get started with $10 or $20.
- Maximum Deposit: Your child (or you on behalf of your child) can contribute as much as your child earns, up to a maximum of $7,000 per year. If your child occasionally babysits, mows lawns, or has a part-time job, any of that income can be deposited into a Roth IRA for Kids. However, contributions cannot be more than the child has earned, and gift money doesn’t count as earned income. So, for example, if their income is $250 for the year, you can’t contribute more than $250, even if you or Grandma and Grandpa would like to make an extra gift to their Roth IRA.
- Withdrawals & Penalties: The amount your child contributes to the Roth IRA can be withdrawn at any time, penalty-free. So, if they needed the money they deposited back for an emergency, they can still access it.
If you’d like to get started with a custodial Roth IRA for your child, both Fidelity and Schwab offer these products. My family uses Fidelity, because it seemed a little easier to me to set up – you can do it all online. You just need basic contact info, social security numbers for you and your child, and your bank account and routing number so you can link the bank account that you’ll be depositing from. Once you’ve made the initial deposit, don’t forget to “make a trade” and select which fund(s) to invest your child’s money in.
My family has found the Roth IRA for Kids to be a really valuable tool to teach our kids about money, and it’s a project that our kids have actually enjoyed doing and learning from. I hope your family finds this to be a great way to learn about managing money, too!
