By Michael D. Koppel, CPA, MBA, MSA, PFS, CITP
Gray, Gray & Gray, LLP
June 2013
“The most powerful force in the universe is compound interest.” – Albert Einstein
Every day we see another statistic that indicates most people have not saved enough to retire comfortably. Many people have simply not paid enough attention to retirement saving and planning until it is too late.
When is the best time to start saving for retirement? The answer is simple: as soon as possible. This includes students with summer jobs who are making, at most, a few thousand dollars each year.
It is highly unlikely that a student working at a summer job will qualify to participate in a company-sponsored 401(k) plan. However, the student will have earned income, which is the only requirement for setting up an individual retirement account (IRA). The good news is that the student, even if he or she is a dependent of their parents, will have no federal income taxes on the first approximately $6,000 of earned income.
(Although they will be subject to payroll or self-employment tax.) Parents should encourage their children to invest some (or all) of this income with an eye toward long term gains.
The question of what type of IRA a student should invest in can be complicated. However, in most cases, if an individual’s future tax rate is likely to be higher than their current rate, a Roth IRA is the correct choice. Since almost all student workers are likely to move up into a higher tax bracket later in life, a Roth IRA is their best bet.
How much is a contribution to a Roth IRA worth for a 15 year old? If we assume that a $3,000 contribution is made and there is an annual return of 8% the IRA will be worth approximately $140,000 in 50 years, when the student is 65 years old. And there will be no tax on the qualified distributions at that point.
To encourage savings, parents and grandparents may consider helping to fund their child’s or grandchild’s Roth IRA as part of a gift and estate tax plan.
If you have any questions regarding this issue, please contact our Tax Department at (781) 407-0300.