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The Online Advisor - February 2000
Consider an IRA for your child
If your child has earned income, he or she is eligible to contribute up to $2,000 each year to an individual retirement account (IRA). Earned income is wages or self-employment earnings (e.g., paper route, modeling, or babysitting). If you wish, you can provide the money for the IRA instead of using the child's earnings.
Starting an IRA at an early age can build a substantial nest egg. If an 18-year-old invests $2,000 annually in an IRA through age 25, with annual return averaging 10%, by age 65 his or her IRA will exceed $1 million. Not a bad return for a $16,000 investment! If your child waited until age 25 to start contributing to an IRA, he or she would need to invest $2,000 a year until retirement to have $1 million.
While the main benefit of starting an IRA early in life is the value of compounding, other benefits include establishing a savings habit, planning for long-term goals, and getting a tax deduction for the contribution. The drawbacks of an IRA must also be considered. Under current tax law, any withdrawals prior to age 59-1/2 are generally subject to a 10% penalty in addition to the income tax due.
A Roth IRA may be an even better option for your working child. While there is no tax deduction for the contribution made to a Roth, the account grows tax-free. Qualified withdrawals will be completely tax-free rather than subject to income tax like withdrawals from a regular IRA.