Can Teenagers Invest in Roth IRAs?

Retirement is probably not on most teens' radars, but it should be. That’s because a relatively small investment today can grow into a substantial sum later, after decades of compounding. A great place to start is with a Roth IRA, which offers tax-free growth and tax-free withdrawals in retirement. Here are a few tips to get your teenager started on planning and saving for their future.

Tax-Free Growth and Income for Retirement

One of the biggest perks of a Roth IRA is the tax break it offers. With a Roth IRA, you don’t get an upfront tax break as you do with a traditional IRA. Instead, your contributions and earnings grow tax-free forever.

This usually works out well for teens. That’s because most teens pay little if any income tax. If a teen has a summer job or works during the school year, their pay makes them eligible for a Roth. Here's how it works:

• Roth IRA contributions aren’t deductible. But when the teen gets older, they'll enter a higher tax bracket and won't have to pay any taxes on that money.
• Contributions can be withdrawn at any time, for any reason, without owing any taxes or penalties. However, the account holder will need to hold the account for a minimum of five years and wait until they are at least age 59½ to take out the earnings to avoid a 10% early withdrawal penalty.

You Need Earned Income to Fund a Roth IRA

Anyone can contribute to a Roth IRA, regardless of age. That includes babies, teenagers, and great-grandparents. Contributors just need to have earned income the year they contribute.

Individuals earn income when they work for someone else who pays them, or when they own a business or farm. While babies are unlikely to have earned income unless they are child models or actors, the type of work teenagers often do—babysitting, lifeguarding, barista-ing, and so forth—generally qualifies. Investment income does not qualify because it's considered unearned income.

The contribution limits on IRAs change periodically based on inflation. For 2023, workers can contribute up to $6,500 a year to a Roth IRA ($7,500 for those 50 or older). For 2024, the limits are $7,000 and $8,000, respectively. However, the contribution can only be as large as the individual's earned income. So if your teen earned $4,000 during the year, that is the most they can contribute.

The pay received must be legitimate and at the going market rate. For instance, parents cannot pay their kids $1,000 an hour to mow the lawn and call it earned income. Ideally, the teen will receive a W-2 to substantiate their earnings. Otherwise, it’s a good idea to keep excellent records from odd jobs that do not provide tax records.

Adults Can Contribute to a Teen’s Roth IRA

The Internal Revenue Service (IRS) does not care who contributes to the IRA. The teen just needs enough earned income to equal (or exceed) the contribution.

This means parents and other adults can match a teen’s earnings and make a contribution themselves. For example, if your teen earns $3,000 at a summer job, you can kick in the $3,000 contribution and let your child spend (or save) their money. Or you could help by contributing a percentage of your teen's earnings—say, 50%.

How to Open a Roth IRA for a Teen

An adult has to open a custodial Roth IRA account for a minor. That’s age 18 in most states and 19 or 21 in others. These accounts are essentially the same as standard Roth IRAs, but the minimum investment amounts may be lower. Many (but not all) brokers offer custodial Roth IRA accounts. Firms that currently offer accounts for minors include Charles Schwab, E*Trade, Fidelity, and Vanguard.

As the custodian, the adult controls the assets in the Roth IRA until the minor reaches the age of majority. At that point, the account belongs to the minor. A minor can continue to invest in a Roth IRA and set themselves up for a sound financial future—as far off as that future might seem.

The Bottom Line

If everyone started a Roth IRA for their kids, there's a good chance more people would be financially prepared for retirement. For example, a single $6,500 contribution made at age 15 could grow to more than $300,000 over 50 years, assuming an 8% annual rate of return. By starting early, you help set your child up for financial success by establishing healthy saving habits and jumpstarting their nest egg.