Even teenagers can start saving toward retirement with an IRA. The only requirement is that they have earned income. IRAs provide tax incentives that will help teens' investments grow faster than in a standard savings account while making it hard to get at for impulse purchases.
While there is a maximum age limit of 70 1/2 for contributing to a traditional IRA, there is no minimum age requirement. You can contribute to a Roth IRA at any age. The main difference in the two is that traditional IRA contributions are pre-tax while distributions are taxed as regular income, while a Roth is funded with after-tax dollars and qualified distributions are tax free. In both cases investment earnings within the plan accumulate tax deferred, or tax free in the case of a Roth.
The maximum allowable contribution to an IRA at the time of publication is $5,000 per tax year, or $6,000 for anyone over 50. There is no minimum contribution except that the income must be earned. That means your teen cannot contribute income on an investment or gifts. He can contribute money he earned mowing lawns or babysitting. However, the teen should have some proof that the income was earned, like a check or a 1099.
You cannot take a qualified withdrawal from an IRA before the age of 59 1/2. Taking a withdrawal from a traditional IRA before that will result in the distribution being taxed as ordinary income and an additional 10 percent penalty tax on top of that. In the case of a Roth, the participant's own contributions -- that were after tax -- can be withdrawn anytime without penalty. While the idea of an IRA is to save for retirement, waiting until age 59 1/2 may be a big commitment for a teen, and since they most likely will not need the tax deduction, the Roth IRA might be the better plan.
While the federal government does not place a lower limit on IRA contributions, many brokerage firms will not start an IRA with less than $1000. Fees may also make it impractical to invest small amounts. However, many banks will open an IRA for as little as $100. This may be the place to start if you are looking to set up an IRA for your teen.
- Photodisc/Photodisc/Getty Images