I bought my son Alex a gift when he turned 21 last year. No, not the latest BMW or even an iPad. I opened a Roth IRA for him with a $1,000 initial deposit.
If you have a child in college, or one who recently graduated, you might consider doing the same thing.
I have a Roth IRA myself and can’t think of a better gift for my son. Opening the retirement account was a simple way to start Alex on the right path, with no effort on his part. I’m banking on him adding to my deposit, of course, and I don't plan to contribute any more to his IRA.
Why I Chose a Roth IRA
The reason I chose a Roth IRA as opposed to a traditional IRA is that this way, Alex's earnings won't be taxed when he withdraws money from the Roth IRA in retirement. On the other hand, a Roth IRA doesn't offer a tax deduction for contributions, the way a traditional IRA can, depending on your income. The Internal Revenue Service has a helpful guide explaining the differences between traditional IRAs and Roth IRAs.
Some people might say I’m not helping my son become responsible about money by setting up the IRA for him. I know their argument: Millenials — his age group — have an enormous sense of entitlement as it is, and Alex should take charge of his own retirement savings.
(MORE: What to Teach Your Grown-Up Kids About Money)
Well, I’d like to see him begin saving for his eventual retirement, but I’d also like to give him a leg up. Times are tough for young people starting out today; they often can't afford to save money for the future. And, unlike many of their parents, they can't count on their employers to provide a pension.
My son, an economics major at Rutgers University in New Jersey, hopes to work for a management-consulting firm when he graduates in another year and a half. If he’s lucky enough to get a job then, and the firm offers a 401(k) retirement savings program, he may be automatically enrolled in that plan.
I hope so. When I worked for corporations earlier in my career (I’m self-employed now), employees whose companies had 401(k)s had to choose whether to enroll in them. Many never got around to it and are kicking themselves today.
I'm Not Telling Him About the IRA — Yet
I'm not telling Alex about the IRA yet because I'd like him to mature a little more first. Otherwise, he might view the money as a kind of emergency fund that he could tap any time, incurring a 10 percent tax penalty for withdrawing funds before age 59½.
I may even wait to tell him until he gets his first job and learns all about 401(k) plans. Maybe then he’ll understand that the Roth IRA is for his future.
I'm not so sure he'll get that notion, though. “Young people don’t think about retirement,” says Jim Kinney, a certified financial planner who owns Financial Pathways in Bridgewater, N.J. “At 25, they think they’re going to be young forever. They have more pressing issues, like wanting a new car. When they’re 40 or 50, it’s more real.”
The IRA Rules for Parents
If you're considering opening a Roth IRA for your son or daughter this year, just keep in mind that your child must have earned income in 2012 (as opposed to income from savings or investments). You can then invest up to the amount of the earnings, no matter how small they are, but no more than $5,000.
(MORE: From Dad to Grad: A Few Words of Advice)
Take, for example, an 18-year-old who'll earn $2,000 mowing lawns this summer. His parents can put as much as $2,000 into a 2012 Roth IRA for him. (My son earns more than $1,000 a year in part-time and summer jobs, so my $1,000 IRA contribution met the rules.)
Just be sure to file a federal income tax return for your child to document to the IRS that he had earned income and qualified for a Roth IRA, says Kinney.
The IRA and His Inheritance
Some people may see my IRA gift to Alex as overkill, since he'll one day inherit some money from his father and me. But who knows how much of our savings we’ll spend as we get older? Or whether we’ll have huge medical expenses or need assisted living or home care?
When I told Kinney that I hope Alex appreciates what I’ve done — and will be wise enough to save on his own — the financial planner brought me back to reality. “You have to realize you have no control over what your son or daughter is going to do," he said. "You just have to hope you have taught them well.”
Taught them well? Judging by my son’s eye-rolling whenever I start a conversation about saving money, I’d say I’ve covered the subject extensively.
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