Teens & Taxes: Should Your Teen Deposit Their Tax Refund Into a Roth IRA?
Americans tend to get a late start on saving for retirement. A 2019 report from the Federal Reserve found that 42% of young people ages 18 to 29 have no retirement savings — and that 24% of Americans, overall, have no retirement savings.
If your teen is getting a tax refund this year, it might make sense for them to get an early start on retirement savings by investing those funds.
But should your teen deposit their tax refund into a Roth IRA?
First, it’s important to note that anyone with earned income — either through W-2 employment or gig work — can open a Roth IRA.
A Roth IRA has certain advantages for taxpayers who expect to be in a higher tax bracket later in life. People can cash out their Roth IRA at the age of 59½, and that money is withdrawn tax-free, since the funds were already taxed when the money was earned. Also, there are no required minimum distributions on the money, unlike most 401(k) plans and other retirement accounts. That can give your teen added flexibility in their later years, because they can let the money sit in the account until its needed with no financial ramifications. They can withdraw retirement funds from places like their 401(k), instead, which has required minimum distributions.
Of course, since teens have so many years before retirement, they might consider a riskier strategy to build up funds. Children and teens are not permitted to invest in the stock market. But you can set up a custodial stock investing account, which will transfer to your child at age 18 or 21, depending on your state laws.
Investing in stocks can be risky, however, with the potential to lose everything your teen has saved. However, investing in stocks can provide excellent financial lessons and the potential to get a tremendous jump start on paying for college, buying a home, or saving for retirement. Because your teen doesn’t have to wait for retirement to tap into these investments, they can be used for any expenses in the future.
If your teen shows an interest in the stock market and understands that a “buy and hold” strategy can be profitable in the long term, consider splitting up your teen’s tax refund between a conservative Roth IRA for retirement and some investments in their favorite stocks.
There’s one caveat. If your teen is actively saving for college or has any credit card debt, they might want to focus on these areas first. Not having enough money for college will lead to student loan debt down the line, so it’s smart to save what they can for what could, perhaps, be the second largest expense of their lives, apart from buying a home.
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