My sister told me she's having her 12 year old son set up an IRA for the money he makes this summer doing odd-jobs and chores, and I'm wondering if I should do the same for my daughter who is 14 and babysitting quite a lot, just so she can get the compound interest benefits.
I know this is a popular idea among financial planners and it certainly is a good one, however....if your objective is to teach your child about managing money, saving it in an IRA may not be the best way to do it. The concept of saving for something as remote as retirement is likely to garner too little emotional engagement from a teen to promote a profound learning experience. Besides, to learn many of life's important financial lessons, the teen actually needs to make conscious, disciplined decisions about how to budget, spend and save money. Socking money away in an IRA is great, but it should be complemented with a regular savings account that is more actively managed and tangible. And if I had to pick one to do first, it would be the regular savings account. In my personal opinion, the life lessons are more important than the few dollars of tax deferral at this age. But reasonable people (and advisors) will differ on that.
I think its a wonderful idea! It can be a great learning tool for your daughter as well.
In order to make contributions to an IRA or Roth, she must file a tax return, and her contributions will be limited to the amount of money that she declares as income. Likely the taxation will be nil - but in addition to the power of compounding, you will likely be providing her with something far more important - an understanding of finances, investing, and taxation. Many people are ignorant in these matters when they are young, and only learn (if they ever to) by making mistakes. This is a golden opportunity on so many levels that it is hard to quantify completely. Go for it!
Jon Castle http://www.WealthGuards.com
Any opportunity to broaden your daughter's financial education is a good one, whether the savings and management are done in a personal or IRA account. You might also consider a 529 plan as a vehicle. Not only will she receive the savings & management aspect, but you may also get additional "buy in" on getting good grades if she financially / emotionally "has some skin in the game." Good luck!
Your daughter will likely thank you someday. Even though her current earnings are modest and unlikely to be sufficient to max out an IRA, you would be teaching her a valuable lesson about investing for the future and the compounding of dividends and interest. It is the good habits and philosophical background that matter far more at this age than the actual dollar amounts invested.
You might also want her to read Richard Russell's great piece "Rich Man, Poor Man." It's simple enough for a teenager to understand and drills home the importance of compounding: http://ww1.dowtheoryletters.com/dtlol.nsf/htmlmedia/body_rich_man__poor_man.html
I will offer an alternative perspective here. If your objective is to teach your daughter about saving, compound returns, and budgeting, open a custodial bank account and consider opening a 529 Plan account or a ROTH IRA. A traditional IRA is an especially poor savings vehicle given your daughter's likely tax situation. Here is why: your daughter's total earned income amount and tax rate are probably low. The principal benefits of an IRA are the current income tax deduction and the promise of tax-deferred compounding, but with a low (zero) current tax rate these benefits are negligible. In short, unless your daughter is earning a lot of income and paying taxes, opening a traditional IRA is a bad idea. Either a 529 Plan account or a ROTH IRA would be more tax-efficient. Even a taxable account that holds capital assets such as equities (which are, for now, taxed at a lower rate than ordinary income) would likely be more tax-efficient than a traditional IRA. Feel free to post back with any further questions. I applaud your efforts!