A: Not at all. In fact, this is a great time to start. The earlier she begins to save and invest, the more money she’ll likely have when she needs it for college – and seeing her savings add up should encourage her to keep setting money aside.
One thing she'll learn by starting now is the power of compound interest. For example, if she deposits $2,000 a year in a retirement account for just four years—and saves nothing more—in 50 years that $8,000 could become $170,832, assuming a consistent annualized 6% return.
As for where your daughter should stash her money, her best bet right now is probably a Roth IRA. Because summer jobs don't tend to produce big paychecks, teens' tax rates are usually low, so a traditional tax-deferred IRA typically wouldn't offer significant advantages. One thing to keep in mind: If your daughter's a minor (younger than 18 or 21, depending on where you live), you'll need to set up a custodial account for her until she reaches maturity.
Working teens can save up to $5,500 a year of earned income in a Roth IRA.
Working teens can contribute up to $5,500 a year of earned income to a Roth IRA. That means your daughter can continue to put a little away throughout the year if she works on weekends or during the holidays. And when she's ready for college, her Roth can help her pay for tuition and other qualified higher education expenses. (She'll pay ordinary income tax on the earnings portion of the withdrawals, but will not be subject to the 10% additional tax that otherwise could apply to earnings withdrawn from a Roth IRA.) If she keeps contributing to the account as she grows older, when she does take money out in retirement, her withdrawals won't be taxed. In most cases, earnings will not be taxed if the account is more than five years old, but state taxes may apply. .
You can find lots of helpful information for teaching your daughter about money management in the "Family and Money" section at bettermoneyhabits.com, including "Helping your teen make spending trade-offs."
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To help teens strike a healthy balance between living for today and saving for the future, watch The Basics Q&A: 3 Smart Tips for Young Investors."
Transcript of Video
3 Questions to Ask Your Advisor
- How do I set up a custodial account for my daughter?
- Should I suggest that my daughter put a specific percentage of her earnings aside?
- What resources can I provide my daughter with to help her think about her financial future?
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Withdrawals of earnings are subject to ordinary income tax, unless you qualify for tax-free withdrawals. In addition, a federal 10% additional tax may apply to withdrawals of earnings taken prior to age 59 1/2.