Did your high school or college student work a summer job? In this episode of Coffee with Brendan, learn about the benefits teens and young adults may reap from investing some of those summer earnings in a Roth IRA.
Roth IRA vs Traditional IRA
Investing Summer Earnings
Investing Holiday Gifts
Hi I’m Brendan and welcome to another edition of Coffee With Brendan. In today's episode, I thought we'd talk about with the summer coming to an end who that there are some parents and grandparents who have kids and grandkids, who are just finishing up their summer jobs and either getting ready to go back to school, go back to college or whatnot and have made a few 100 or even a few $1,000 over the summer doing a job. This presents a pretty neat opportunity for the kids when it comes to investing and more specifically, investing in retirement accounts. So yes, even if they're 16 years old, they if they made an income, get a paycheck, and ultimately will get a W2 at the end of the year, then they're eligible to contribute to a traditional or even a Roth IRA. And for most of these kids, I would strongly recommend a Roth IRA for a number of reasons. But and we'll get into those reasons in a moment. But first and foremost, let's get a little bit of a background on IRAs versus Roth IRAs.
So that's one of the main questions I get from clients. And it's pretty important thing to know about. So I'm going to spend a little bit of time during this episode actually talking about them. So on the left is Roth IRA on the right is traditional IRA. And the big, big thing here is Roth IRAs are made with after tax dollars. But that pretty much means is when you make contribution, you're able you have to make it with dollars that you can not get a deduction on. So there is no benefit today to into investing in a Roth IRA. Whereas a traditional IRA is almost the exact opposite, you actually do get a tax deduction for making a contribution to a traditional IRA.
So why am I saying that these kids and grandkids that have summer jobs should be looking more at the Roth IRA versus the traditional IRA. The big, big reason is that whatever the kids invest, or when they put their money in, they probably don't have a ton of money. And up until right around $10,000. They don't have to pay tax on that money. So if they only make, let's say, $6,000 over a summer, they don't have to pay tax on that. And in most cases, of course, if they have investment income from investments that they have, whether it's UTM a accounts or they you know, maybe they were a child actor, and they they actually do have a ton of money. But long story short, and most kids won't have any, any taxes to pay, and therefore, the traditional IRA is not so important. Because, you know, what is it deduction, a deduction is reducing your incomes so that you pay less in taxes? Well, if you're already paying zero, the benefit of the traditional IRA kind of goes out the window.
So what do you get? If you don't, if we're not looking at the contribution piece, then then where is the big benefit? big benefit is with a Roth IRA, all the earnings that that child makes on that money, grow tax free, and if they're 16 years old, and my goodness, if they got a $6,000 summer job, they could make a contribution of up to $6,000. That's the upper limit to the to the maximum that they can put into a Roth IRA or a traditional IRA, they don't get a tax deduction. But if you look at the traditional IRA, you don't really get a tax deduction either, because the kids are ultimately not going to be paying any taxes. But what you do get is tax free growth with the with the Roth IRA. And with the traditional IRA, it's tax deferred. What does that mean? And why did they seem very similar, but very, very big difference? A tax free Roth IRA truly is tax free. So you put $6,000 in and it grows to $60,000, then that if the $4,000 of growth is tax free, versus the traditional IRA, where you put $6,000 in and maybe it grows to $60,000, when they ultimately take the money out that entire $60,000 that that that account is made up of is taxable, and it's taxable at whatever their tax bracket is when they actually start taking money out.
So, long story short or when a child is making money, they should be making contributions to their Roth IRA or to that to a retirement account. And as I've mentioned earlier, I would strongly recommend the Roth IRA. There are a couple other big benefits to a Roth IRA, one of which is that yes, down in the early withdrawal penalties and all this stuff here, you do see that there are penalties to taking money out before age 59 and a half, except for Roth IRA contributions, Roth IRA contributions can be taken out at any time, penalty free and tax free. So you put in $6,000, it grows to $8,000, you can take back that $6,000, but you do have to keep in the $2,000 of growth.
So this one's a nice, short, sweet Coffee With Brendan, that's my big takeaway from this is that if there is if a child does make money, there are a number of planning opportunities that you have, that you should definitely take advantage of.
You know, another thing that you may do, you know, if you have some extra money, and you give child or grandchild, let's say $1,000, or Christmas, instead of just giving them a check for $10,000, if they had $1,000 of income, they could actually, you could actually take that $1,000 and help them open up a Roth IRA and put that $1,000 that you normally would give them a Christmas time, or or holiday time. Sorry. And, and put that into a Roth IRA. And what does that do, of course, what we just talked about, grows tax free, and who knows, you know, maybe it'll grow to some some big number. But on the flip side, you also are teaching them a little bit about investing, which I think everyone should learn a little bit more about as early as possible, and get them invested in some good, you know, blue chip type companies. I can't mention any companies on this without my compliance department getting upset with me, but think about some of the household names that everyone uses. And, you know, it'd be interesting for a child to learn a little bit more about some of the companies that they do business with on a day to day basis with their mobile phones or with their, you know, the different subscriptions that they have for movies and TV shows and things like that.
So that's all I'm gonna say about that before I get myself in trouble with our compliance department. Again, if a child has earned income over the summer, or even throughout the year, I mentioned over the summer, just because summer is coming to a close, but let's say they have a part time job that they, you know, work at the hardware store, you know, every Saturday, well, again, they may have $6,000, and that $6,000 could be put into a Roth IRA. Or if you do give your child or grandchild any kind of cash compensation or cash gifts, typically of birthdays, typically around the holidays. It could be used to fund a Roth IRA with that money and then again, get them on a good learning track to learning more about investments and give them some tax free income and their retirement.
That's all I got for today. I hope this was helpful. And if you have any questions, of course, definitely feel free to reach out to us. Thanks so much.
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