Is a Roth IRA good for a high schooler?

Question

I am a high-school Senior who will not earn enough income working this summer to have to pay income taxes. I have a full ride to college, so I was thinking of using my earnings/savings for retirement. Does putting my earnings in a Roth IRA mean that I wouldn't be paying taxes on those savings at either end (since I don't pay income taxes now, and you don't pay taxes when you withdraw from a Roth IRA in retirement)? Or am I not eligible for the Roth IRA?

Edit: If I understand correctly, I can only put money in a Roth IRA that I earned by working? (So not my previous college savings, which were a mix of earned and gifted from relatives).

Answer 1

You are correct that if your income is low enough that you don't have to pay taxes, then a Roth will let you avoid taxation at both ends, because Roth withdrawals are tax-free.

You are also correct that you can contribute only earned income to the Roth. More specifically, you cannot contribute more to the Roth than your taxable compensation in that tax year. (Note that there are additional limitations besides this that may be lower, but based on what you said it sounds like you would not be hitting those. See this IRS page.) So even if you have money that you earned by working in previous tax years, it's too late for that to matter for contributing to the Roth; this year you can only contribute up to the amount you earn during this year.

However, if you are working during the summer and have enough money that you don't need that income (e.g., you are still living with your parents), putting all or most of your pay into a Roth can be a great idea. Even if you only earn a small amount of money, getting it invested early can produce huge gains over a long period of time. Your decision to begin saving for retirement now is wise and your future self will undoubtedly thank you for your foresight!

Answer 2

If you can assume:

• you know that watching your real IRA grow isn't a better teacher than watching a simulated portfolio, and
• you're starting a high-paying job post-graduation

Then no, I wouldn't recommend putting your high-value dollars into an IRA now. Save it instead of risking you'll need the money, then invest it all once you build up an emergency fund.

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If -- after watching your high school $x amount in your Roth IRA grow to $2x or $4x by the time you have paid off some undergrad loans and have spare investing money -- that now convinces you to make solid contributions to your IRA/401k, then that's a good lesson to learn and it costs much less than $x opportunity dollars. But you could start a simulated retirement profile with $100k and watch that grow instead.

I don't think I needed that lesson; I've always been savings-minded.

After 4 years of undergrad and paying for wedding and moving, I had less than $x left in savings. It would have decreased my stress to have instead kept that original $x dollars in savings, so I didn't have to consider any withdrawal penalty.

After a year of working, my savings was around $30x and I'd contributed around $6x to my 401k. The marginal value of those $x dollars was higher to me at the end of high school and at the end of college, vs. once I had a full time job making 3 times as much as I made in high school / college. Based on that logic, I should have also kept more low-interest student-loan debt when that was an option, instead of using savings. But they don't teach these things in high school. </personal-story>

Answer 3

No.

You are not paying taxes now and presumably for the next few years. A brokerage account would give you the same benefits of Roth IRA except you have access to the money if you need it.

You know when you might be have to start paying taxes. The year before you graduate so you could realize all the gains you have or if you left them along they would be in capital gains time so you could let it ride.

I would bet the average college graduate with their first job isn't able to max out both their IRA and 401k. So you will have time to move some of the money into an IRA then, or would just be able to contribute more as you would have this brokerage account.

Answer 4

My kids did this exact thing.

We had talked about putting money into a retirement fund. The Roth IRA made the most sense because they if they paid income tax on the contribution (0%) they could withdraw it tax free in retirement. The general guidance is that if the tax rate in retirement will be higher, then you want to use a Roth.

One of the best parts about IRA contributions is that you can wait until April to make the contribution, so you can wait until you know how much you can contribute.

If I understand correctly, I can only put money in a Roth IRA that I earned by working? (So not my previous college savings, which were a mix of earned and gifted from relatives).

You need to decide how much you want to contribute. There are annual limits, linked to either your income or $6,000 whichever is lower. The actual money can come from your savings account, or even a gift from a parent, or grandparent. The limit is linked to your income, but the funds can come from anywhere.

Answer 5

There are a couple of options for you with nearly equal value. It mainly depends on your goals, but the differences in outcome are minimal. Are you attempting to get a head start on retirement? Are you just trying to get your extra money to work for you?

1. Roth IRA. This option is fine because you will never have to pay taxes on this money, and you can withdraw whatever you put in at any time. However, any investment gains you see will have to wait until retirement. In that respect, a Roth IRA can basically be treated like a savings account that gives some small benefit to retirement.

2. Taxable brokerage. This option is also fine because with your low income, it is unlikely that you will pay any taxes on this money. If you hold onto your investments for at least a year, and you remain in a low tax bracket, you will pay nothing. If you sell your investments in less than a year, and you are in the lowest tax bracket, you will still not have to pay any taxes. You can realize your gains and use them to help fund your near future expenses.

If you are primarily concerned with saving for retirement, go with the Roth IRA. If you want additional flexibility to use all of the money you invest now, go with the taxable brokerage. Ultimately, either will be fine. Personally, I would go for the taxable brokerage for now since you will have a lot to pay for in college and not a lot of money to work with.

Answer 6

This is a great question and the answer is a bit dependent upon other factors in your life. Presumably you earned less than $400, not a lot, although you should be proud. To me it boils down to how can we change that into "life-changing money"?

Putting it in a Roth is a great idea and certainly not a bad one. For every $100 you invest in a Roth it will grow to about $2,400 in today's dollars in 47 years (when you are 65). A good idea, but not really life-changing money.

Some would be far better served to put this money in a simple savings account. The most important thing they could do is increase their lifetime earning potential. That might mean going to college, or obtaining a skilled trade. Scholarships can go away, or not provide for all anticipated needs so protecting against that those negative events is the best way to transform this into life changing money. Income is the highest correlation to becoming wealthy according to The Millionaire Next Door.

Some would advocate putting into a Roth anyway as contributions can be withdrawn. I would not do this as there is a 5-year holding period and presumably this person would be out of college by then.

I don't think that is you, however, Roth is probably best. You already have college savings and presumably a very supportive family. Not everyone has that, consider yourself blessed please. Yes, you can only contribute earned income.

Great work on all including earning some from a summer job.