One common regret of adults is that they didn’t start saving for retirement early enough. Instead of putting away their money inside an IRA that would compound hugely over time, they take the money from their first jobs and spend it on gadgets, gizmos, eating out, and other things. When they hit their late 20’s, 30’s, or even 40’s and start getting serious about retirement, they’ve missed out on a decade or two of critical doubling time.
So today I’m going to introduce you to a strategy my parents used to introduce me to the concept of saving and investing as a teenager with my first jobs in restaurants and grocery stores. I’m planning to use the same strategy with my kids in their first jobs. It involves a custodial IRA, an investment company, and the Bank of Mom and Dad.
My Story – An IRA As A Teen
Back when I was a teenager, I was looking forward to the freedom that first job would provide. No longer would I have to depend on other people to buy things for me – instead I could buy them myself! I picked up a television for my room, a Playstation, and some video games for myself to play. And the other thing I picked up was a traditional IRA invested in the Janus 20 fund.
You see, my father had made me an offer my money-interested teenage self couldn’t refuse. I had already read The Wealthy Barber (and it changed my life) a year or so before at the library, and had become interested in what saving and investing could do to change your life if done consistently over a long period of time. To help get me interested in saving for retirement, my father made me a generous offer.
For every dollar I invested into an IRA, he would match a dollar. That’s right, I would get an instant 100% return on my money (if only I still had that offer today!). So I saved up a few hundred dollars, he chipped in a few hundred, and we were off to the races.
Now this was the late 90’s, when stocks were soaring with no end in sight. I’m fortunate that during my investing timeline I have experienced two significant downturns. Why is that fortunate? Because I know how I really behave when the market tanks and everyone is yelling to sell. Trust me, how you really behave and feel when your hard-earned money evaporates is different than how you think you will behave and feel.
The IRA we opened was a traditional IRA, and it was invested in the Janus 20 fund. I can very clearly remember my father being jealous of the returns I was getting in this fund-it was soaring in 1997-1999! Well we all know what happened in the year 2000 during the dot-bomb. It crashed to earth and stayed there. When I became a Boglehead in the early 2000’s, I transferred the IRA into an S&P 500 index fund and have had it there ever since.
Today I keep that IRA in a separate account from my other retirement money. Technically I could roll it in with my 401k rollover funds but I like keeping it separate and seeing it grow. It’s a reminder of my teenage self, and her setting aside money thinking that one day, it would grow. And yes, teenage self, it has.
What I’ll Do With My Kids – The Same and The Different
Since my 14 year old son has started high school, I’ve been thinking lately about his first real teenage job. After all, it’s coming up in about two more years. I do plan to have my kids work, at least during the summer, to earn valuable job skills like coming in and leaving on time; listening to your boss; getting along with co-workers you don’t like, etc. I also want them to learn valuable life skills around how much things really cost vs. how much you make; budgeting your money; and paying yourself for the things you’ll use (like cell phones, cars, and insurance).
I do think matching a teens IRA contribution is a great way to incentivize them to save and invest. It’s also a wonderful way to teach them why it’s important to start early and save often for retirement. Yes, the last thing teens getting their paychecks want to think about is what saving and investment strategy they need to deploy in order to eventually retire. That’s why it’s important to start them with a strong incentive, and have conversations with them about how compounding works and why starting early with small amounts will put them ahead of people that save more later. Here’s a short video I’ve shown my kids to explain how compounding works via the “penny doubling every day” example.
There are two key things I’m planning to do differently than my parents did:
- Indexing All The Way: The fund I originally invested in was the Janus 20, and in the late 90’s I believe it contained some of the high-flying technology stocks that crashed to earth in the dot-bomb. Instead of an actively managed fund, I plan to do the IRA and match into a passively managed total stock market index fund.
- ROTH IRA: As I mentioned, mine is a traditional IRA. However, for a teenager you frankly can’t beat a ROTH IRA. They’re likely paying almost nothing (or actually nothing) in taxes every year, so the tax deferred benefit of a traditional is low. And if that money grows and compounds for 40-50 years, that’ll mean a nice chunk of tax-free change down the line.
Something To Show Your Kids
If you’ve been into personal finance and investing for a long time like I have, you’ve probably already seen those charts that show when someone starts saving and investing in their 20’s, they get – and stay – ahead of those who start later. When I was first starting out, those charts hugely influenced my thinking, because I could clearly see just how bad the penalty for waiting was. And I’m sure glad I started when I did, rather than waiting until I made a higher income and it would be “easier” to put money aside.
So here’s a handy example you can show your kids or your significant other, to demonstrate exactly how beneficial this strategy will be to them.
Lets say you decide to deploy this IRA match strategy from the time your child is 16 with their first job, until they’re 22 with their last college job. Let’s also be modest and assume your child will put aside $1,500 per year, or $125 per month/about $32 per week. You’ll match that $1,500 and put it all into a ROTH IRA in an S&P 500 index fund earning 8% per year average over time. Lets also assume your child will start pulling the money out at age 62 (for ease of math). So you’re going to set aside $250 total per month for six years, and then never put in another dollar. That means at 22 you’ll have $18k sitting aside to grow.
How much would that $18k become in 40 years?
Almost four hundred thousand dollars.
That’s four hundred thousand dollars of tax-free money, all from your child setting aside only $125 per month from their first jobs. Now that’s the power of compounding.
The other great thing about a ROTH is that theoretically if you need the money before traditional retirement age, you can withdraw your contributions tax-free. So your child will be able to take out those $18k in contributions for an emergency, and leave that interest there to continue to grow and compound. Of course, you need to teach your kids the true meaning of emergency, which unfortunately does not include their desire for the latest and greatest video game or sneakers.
I Want To Hear From You!
Did your parents teach you about saving for retirement-or do you wish they had? What do you think about this strategy? Let me know in the comments!
Want to learn more about teaching kids about money? Check out this great page with my top articles and resources I’ve found from around the web.
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