I remember when I started saving for retirement. My employer announced that they were going to begin a 401k plan with a match. I didn’t know much about investing at the time, aside from the facts that I:
- Wanted to retire as early as possible,
- Knew the match was like free money (I like free money)
- Heard 401k plans are a good way to go.
Starting at 21, I was probably ahead of the curve. Many of my friends began their savings the next year, after graduating from college. I’m certain that there are many others that put off saving well into their careers. The point I’m trying to make is that most people are faced with the option of saving for retirement by the time they have a job. That’s not to say that they make the smart choice of actually opening an account.
The problem with that is they are missing out on earning good returns through the college years. That void is made bigger if you go to graduate school, take longer to get your Bachelor’s degree or don’t get the right job straight out of college.
If you want to get your children out ahead of the curve, you should encourage them to open a Roth IRA at age 18.
The Benefits of Starting Young
You have only two weapons that are within your control when investing for retirement: time and money.
These two savings tools can also substitute for each other. I wouldn’t recommend it, but if you have a lot of money, you can afford to save over a shorter period of time. The reverse is true as well. If you have a lot of time, you can save small sums of money and get the same results.
If you were to open a Roth IRA at age 18, save $1,000 each year until you are 55 and earn a 7% return each year, you’d have saved $183,784.63. Now, if you waited, went to college and started saving at age 23, you’d need to save $1,667.46 each year until you were 55 to earn the same returns. Your payment would nearly double if you waited until age 25.
When you are 18, you have a lot of time before retirement. Starting early could mean having more disposable income, without sacrificing retirement goals.
Why a Roth IRA
I was very specific in my recommendation. You should open a Roth IRA at age 18. Here’s why.
You have a choice between two different tax benefits when choosing a retirement savings account. 401k and Traditional IRA plans let you deduct your contributions from your taxes. Contributions to a Roth IRA are made with after-tax dollars, but you don’t need to pay taxes on withdrawals when you are in retirement.
Personal finance experts are divided over which benefit is the smarter choice. However, at age 18, you aren’t likely to make enough money to get a large tax advantage. Make under $3,600 and you have no tax liability. This means that young adults using a Roth IRA could completely avoid paying taxes on any funds from their Roth IRA.
Additionally, some experts suggest that by opening an IRA at a young age, you might amass enough savings that by the time you’re ready to have kids, you’ll have you’re own version of a quality life insurance plan and can avoid paying those premiums to an outside company.
There are some potential complications. For example, you child will need to save a few thousand dollars to open an account. However, the benefits are starting early is a goal that pays richly at retirement.