What's the best age to start saving for retirement? A common answer is when you start your first "real" job and can sign up for a 401(k) or other plan offered by your employer.
But often children are working long before that. If their parents encouraged it, probably even more young people would do appropriate work, such as babysitting or dog-walking, for pay. And that's all it takes to do what may be the best way to help your kids get a head start on retirement savings: Put some or all of their earnings into an IRA.
The demise of traditional pension plans, uncertainties about the future of Social Security, and the increasing reliance on 401(k)-type plans to finance retirement are all good reasons to expose your children to the idea of retirement savings at an early age, many financial experts agree. What's more, with the potential of 50 years of compounding returns, even a modest amount of money in an IRA now can turn into very big bucks.
Record-Keeping Is a Must
Eligibility to make IRA contributions requires having income from work rather than from gifts or inheritances. The work can be for other people, such as your neighbors, or for your own business. If you're self-employed or have a small business, you can hire and pay your children, claim a deduction on your business taxes, and insist that the children put their earnings into an IRA.
It's important that you keep detailed records. Financial planners I spoke to said if you're basically having your own child do chores in return for an allowance, don't try this. If your child is working for others, then keep a log of dates, the type of work, and the employer.
Steven Podnos, a physician and financial planner in Merritt Island, Fla., opened IRAs for his three children "as soon as they were old enough to reasonably do things for my business, when they were around 12 years old." They've done secretarial work, filing, computer maintenance, and phone calls. Now, 20-year-old Rachel, a college sophomore, has about $50,000, high-school senior Lauren has about $36,000, and high-school junior Jake has around $14,000. Podnos was able to persuade his children to save by showing them how their money could grow. He says the older two kids understand, but he's not sure the youngest "gets it" yet.
Cheryl Costa, a financial planner in Natick, Mass., pays her sons, Matthew, 14, and Eric, 12, to help stuff envelopes for her firm's quarterly newsletter mailings. The boys are only earning about $200 or $300 a year right now, but she opened accounts for them about two years ago because, "I realize what a powerful tool Roth IRAs are for building retirement savings." To try to convince her kids, "I make a spreadsheet and show them" how much money they could save, she says.
Costa estimates that her 14-year-old's current account of $1,500 could grow to about $78,000 at an 8% return over the next 51 years, or more than $193,000 if the return were 10%—and that's without adding any money to the account.
If your children insist that they'd rather use their earnings for video games and Roller Blades instead of retirement, try this: Open the IRA with their earnings and then give them a gift equal to what they invested. That way, they'll have money to spend and perhaps, over time, they'll be impressed at how the IRA account grows and decide to keep on contributing. (The IRS doesn't require you to report gifts as long as they're under $12,000.)
Aggressive Is O.K.
Costa chose Roth IRAs for her boys because although income tax must be paid on contributions, when the money's withdrawn there will be no tax. And at the boys' low income level, they won't owe tax now anyway. If she had chosen a traditional IRA instead, Matt and Eric would have to pay income tax on it when they withdrew the money.
So what does it take to set up the account? The child is eligible to deposit some or all of his earnings, up to $4,000 per year, in the IRA. You set up the account using your child's Social Security Number with a financial-services company. You may need to shop around.
For example, Fidelity won't allow anyone under 18 to have an account in his or her own name, but Vanguard will. Until your child turns 18, you're the custodian of the account and children can't take the money out independently.
Investment options are the same as with any other IRA. Costa decided to "invest aggressively for my boys, because it's such a small amount of money and the child's account literally has 50 years" in which to grow. Discussing how to invest the money could be educational and also a way to get your children more involved in and committed to the account.
Don't Forget Charity Lessons
The usual rules on IRA withdrawals also apply. With some exceptions, taking money out before age 59 1/2 results in a 10% penalty and a bill for income tax. With the Roth IRA, the account must also have been open at least five years in order to avoid an early withdrawal penalty. See IRS Publication 590, Individual Retirement Arrangements,, for details.
Despite what many see as the plusses of starting children on retirement savings early, there are naysayers who warn parents against reimbursing kids for the money they've earned in order to sock it away in their IRA. One is Bob Nusbaum, a financial planner in Pittsburgh.
In an e-mail to me, Nusbaum wrote: "It's hard to imagine a better way to provide a child with a lifelong sense of entitlement and lack of incentive than to take care of their retirement before they ever even leave your house. If parents are in a position that they have such a surplus of money that funding their kid's retirement is an option, maybe they should consider some other alternatives. For example, show them ways that money can be used to help others in need—disadvantaged and/or sick children would be a great choice."
Nusbaum's was the minority opinion among people I spoke to about helping children save for retirement. But even if you agree with him, you could still encourage the working and saving habit in your family by not giving the gift to match the earnings kids contribute to their IRA.
In addition to writing Your Retirement for BusinessWeek.com, Hoffman is the author of The Retirement Catch-Up Guide and Bankroll Your Future Retirement with Help from Uncle Sam. You can contact her through her Web site, www.retirementcatchup.com.