Why kids should stash summer job cash in a Roth IRA

Teen employment spikes in May to highest level since 2006
Teens scope out summer work at a youth jobs expo in Denver.
(Matthew Staver / Bloomberg)

A summer job is the perfect opportunity for parents to introduce kids to some smart money habits, such as saving. And there’s a good case to be made for putting at least a portion of each paycheck in a Roth individual retirement account.

But how do you push something with the word “retirement” in its name to a 15-year-old? Here are four Roth IRA selling points to highlight:

Investing turns money into more money

When you invest money over a long period, that money grows. For 15-year-olds who invest $3,000 worth of summer job paychecks in a Roth IRA, that could grow to $4,500 by the time college graduation rolls around, assuming a 6% average annual return.

If your teen leaves that $3,000 in the Roth IRA for longer — say 50 years — it would grow to more than $55,000. And what if your teen added $3,000 every summer, from age 15 to 22? At college graduation, the Roth IRA balance would exceed $30,000, a figure that could grow to more than $380,000 by retirement.

Worth noting here: The Roth IRA contribution limit is the lower of $5,500 or your teen’s taxable compensation for the year. If taxable compensation is $2,000, that’s the most he or she can contribute to an IRA. This is good to know if you decide to encourage your wary teen with an earnings match. Doing so would give the kid spending money while still putting his full paycheck in the Roth.

Roth IRAs are flexible

This is not the type of retirement account that swallows your teen’s money and refuses to give it back for 40 or 50 years. Because your teen would make contributions to a Roth IRA with after-tax dollars, he or she can withdraw them at any time, with no taxes or penalties.

The earnings on those contributions, like that $1,500 in the first example above, aren’t as easily recovered. Withdrawing them early typically means paying a 10% penalty and income taxes.

Of course, removing contributions will stunt or eliminate investment growth. But knowing it’s possible to get this money back could put your kid at ease.

A Roth IRA isn’t just for retirement

There are a few circumstances that also allow your teen to take out earnings without penalty.

As long as the Roth IRA has been open for five years, your child can take out up to $10,000 in earnings to buy a first home, tax- and penalty-free. He or she can also use Roth IRA earnings for qualified education expenses such as college tuition, although only the penalty will be waived in that case.

The key thing to highlight here: A summer spent pushing a lawn mower could mean not having to move back home after college graduation. At the very least, it might mean walking across that graduation stage with a little less student loan debt.

Qualified Roth IRA distributions are tax-free

Because Roth contributions are made with after-tax dollars, there’s no tax deduction on contributions as there is with other retirement accounts, like a traditional IRA. For a low earner such as a teenager with a summer job, that tax deduction on a traditional IRA is unlikely to be worth much, if anything.

That makes the main benefit of a Roth IRA even more attractive for kids: Distributions starting at age 59 1/2 — or for that first home — are not taxed. And for teens who just learned the burn of watching hard-earned money get siphoned off to the IRS, skirting taxes may be something they’re very interested in right now.

Arielle O’Shea is a staff writer at NerdWallet, a personal finance website.