We often hear from retirement investors that they wish they’d started saving for retirement sooner.
Does this ring true to you? If so, you might feel compelled to pass that wisdom on to your children or grandchildren — or maybe even start a retirement savings account for them.
Parents can open and deposit money into a bank account for their children with the plan that the funds are for the childrens’ retirement.
This can help teach good saving habits, but the child will not reap as much in the way of compound interest as they potentially could with other accounts. Fortunately, there are child-friendly individual retirement accounts (IRAs), both Roth and traditional, that children can invest in if they have taxable income.1 Many of these are “custodial accounts,” meaning they’re managed by a parent or guardian until the child becomes an adult.2
Note that there are some restrictions on IRAs. For example, there’s a limit on how much an individual can invest each year. For 2017, that amount is $5,500 if you’re under 50 years old. You also can’t invest more than your taxable income each year. So if your child earns less than $5,500 per year, they can only invest what they make, not the full $5,500.3
Convincing a child to invest most of their earnings in a retirement savings account might be hard, but there are ways to encourage saving:
- Match their contributions up to the allowable investment amount if you can. That way they can keep part of their earnings.
- Ask friends and relatives to contribute to the IRA instead of giving birthday or holiday gifts. Your child can keep their paycheck and still contribute to the IRA.
While setting up an IRA for your child is one way to help him or her save for retirement, it’s not the only way. Teaching children financial literacy, the basics of compounding interest, and the value of long-term saving can also help set them up for a successful financial future. Even if they don’t open an IRA after receiving their first paycheck, knowing personal finance basics can make a world of difference for your children when they’re faced with financial decisions from childhood into their adult lives.
We’ve said it before: Children learn from you, so leading by example is another good practice.
If you need to improve your financial habits before diving into personal finance 101 with your kids, you’ll want to start by brushing up on the basics. We have a variety of resources to help.