Savings That Start With The First Paycheck

By Martha M. Hamilton
Sunday, May 20, 2007

Remember the first job you got when you were a kid?

You couldn't wait to get that first paycheck so you could run out and open a retirement account, right?

Nope. Me either. My first couple of paychecks from Mr. Blankenship's dry cleaners bought me a powder-blue Bobbie Brooks skirt and sweater, a fashion choice influenced by Seventeen magazine and "American Bandstand."

Today's working teenagers, I'm happy to say, aren't much different from previous generations when it comes to spending that first paycheck. Somehow the notion of a 15-year-old lusting after a Roth IRA is disturbing -- though it may make sense for their parents and grandparents to consider setting one up for them.

I think 16-year-old Marshall Hamilton is probably typical of today's working teens. Marshall, my grandson, has worked part time over the past several years at Montrose Christian School in Rockville, mowing grass, mulching and otherwise helping to maintain the landscape.

The first couple of checks he earned went toward an iPod, a $50 iTunes gift card and a protective case and dock. His second purchase was a birthday gift for his father, a generous gesture.

As time went on, he began saving his money for a down payment on a $1,000 car -- but no IRA. "No, I was too immature. I was too busy spending my money," said Marshall. "It was the first time I had money, and I didn't really know what to do with it."

I actually think Marshall is right where he should be. He's learning to work for the extras he wants and to save for his goals. If he's not worried about retirement, that's as it should be at this stage in his life.

But parents and grandparents of working teenagers might want to be thinking about opening retirement accounts for them, according to Tim Speiss, a partner at Eisner, an accounting firm. "It's a phenomenal idea, and we have a number of clients who do it," he said. Because the retirement fund might have as many as 55 years to grow, "there could be tremendous accumulation with modest contributions."

The key to eligibility for a traditional or a Roth IRA is earned income. You can't open an IRA for an individual who doesn't have any. "The child could actually spend the earned income or invest it otherwise and could be gifted an amount that could then be contributed to the retirement vehicle or savings vehicle," said Speiss.

Take a 15-year-old who earns $1,500 this summer. If her parents contribute $500 to a traditional or a Roth IRA this year, and keep that up until she turns 21, in 50 years -- assuming an 8 percent annual return -- she'd have $208,000 from the $3,500 originally invested. That might not be enough to live on in retirement 50 years from now, but it's a good payoff from a relatively small investment.

But the bigger payoff may be in the opportunity to talk to your child or grandchild about the importance of financial planning. It's a great way to talk about how compound interest works -- earning money on the money your money earned the previous year. And it's a great way to explain the trade-off between risk and return. Picking the right investment could be a family undertaking, with the full participation of the teenager. And, with any luck, the teenager will continue adding to the account when she grows up.

Bhru Patel of Plymouth, Mich., has been thinking about helping his 13-year-old daughter, Sarrina, get started with a Roth IRA. Sarrina has earned income from babysitting and doing small landscaping jobs for the neighbors and the family. "I want to explore the possibility of using her income to fund a Roth in her name and do this every single year," he said. She would take over after college when she begins working full time.

Sarrina and her younger brothers, 8-year-old Nikhil and 4-year-old Meehir, all have bank accounts and put some money aside for four purposes -- investing, saving, spending and donations. Originally the kids divided their money equally, but now the older two are favoring investment, said Patel. Helping to get them invested in retirement accounts as they get older "will give me great comfort," he said. That way he'll know that the children "will be financially on the right track from their own investments and not have to rely on any inheritance from us."

You can open IRAs through banks, mutual funds and investment companies, but the rules differ among institutions. Some require that the person for whom the IRA is being opened have W-2 income, which is income that the employer reports to the IRS. Someone who mows lawns or babysits, for example, may have to look elsewhere to open an account but could be eligible if he reports that income to the government, said Speiss.

The minimum to open an account with Charles Schwab is $1,000, though that is waived if you set up monthly transfers of at least $100 a month. Other institutions have no minimums except for those required by whichever investment you choose. For instance, most mutual funds offered by Fidelity Investments require a minimum investment of $2,500, according to a spokeswoman. Investing in a certificate of deposit or a money-market fund through a bank may require a relatively small starting deposit. A teenager who wants to open an IRA with PNC Bank could get started with an IRA savings account for $25 or an IRA invested in a certificate of deposit for as little as $250.

When a teenager is opening an IRA, a Roth IRA probably makes more sense than a traditional IRA. The difference between the two is when the money is taxed. With a Roth IRA, it's taxed going in; with a traditional IRA, it's taxed coming out. Most 16-year-olds are probably at a lower tax rate today than they will be in the future, so it makes sense to opt for paying the tax today, while assuring retirement security for many days after tomorrow.

Do you own a small business? Have you struggled over how to provide retirement benefits to your employees? Would you be willing to talk to me on the record about your situation? If so, please e-mail me

© 2007 The Washington Post Company