Many teenagers like to get a job, to have some spending money and build some autonomy. That job could be the key ticket to their financial future, and most teens (and their parents) have no idea how powerful that little paycheck can be.
I worked throughout high school, and I made a lot of money over the years. I had few expenses, so I had ample opportunity to do smart things with this money. I didn’t know much about money, so I spent all that cash instead of setting myself up for financial success. What a waste! Hopefully, you can help your teens make much smarter decisions.
I know it sounds crazy to be thinking about retirement when you get your first job, but this is exactly the right time to start putting away money into an Individual Retirement Arrangement (IRA) account. There’s no minimum income required to start saving in an IRA, and even non-formal income can be counted if you claim it on your tax return. The IRA contributions don’t have to be made with the teen’s money, either. Parents, grandparents, and kindly aunts can contribute to an IRA for a working teen, as long as the total contribution doesn’t exceed the teen’s earned income or the IRS contribution limits ($5,500 for 2014.)
Every contribution made during the early years can grow to a large retirement account, thanks to the principles of compounding interest. From the math-smart people at USAA,
Youngsters may have slim bank accounts and modest incomes, but they have one asset in great abundance: time. And when it comes to building a nest egg, that’s a significant advantage.
“If you start young and save actively for a long time, then given historic rates of return you’ll accumulate a very comfortable nest egg,” says Anthony Webb, a senior research economist at the Center for Retirement Research at Boston College.
How comfortable? Let’s say you help a child start an IRA at age 15 at a pace of $2,500 every year through age 22. At age 67, assuming an 8% rate of return, that relatively modest contribution of $20,000 would grow to over $900,000. That’s thanks to the power of compounding. In other words, you earn interest on your original investment, but also interest on the interest accrued through age 67.
Now, let’s step back and assume that instead of just leaving it at that, the child, turned young adult, picks up the good habit, takes over at age 23 and starts adding $5,500 a year. The beauty of compound interest means that he or she would have over $3 million socked away at age 67.
That’s a lot of money, and you can’t replicate those results if you start saving later.
I have a friend who benefited from her father’s financial wisdom and generosity. When she started working, he began contributing to an IRA for her. When we graduated from college, she was in a good position to never save again and still potentially have a MILLION dollars at retirement. I can’t even imagine the feeling of security provided by that good start.
Help your child select a good, low-fee bank account and teach them how to maintain their accounts properly. This includes tracking ATM transactions (and fees) and using checks.
Most Americans have no understanding of our tax system. Start teaching your child about taxes when they get their first job and the taxes are simple. You can learn a lot from a 1040EZ tax form. If you don’t understand it, ask a savvy friend or family member to go over the basics with your child.
Once your teen has mastered the basic structure of tax payments, you can start introducing more advance concepts such as proper withholding and using the tax system to minimize your tax liability.
There are a lot of pros and cons to giving credit, particularly credit cards, to teenagers. However, allowing limited access to credit can be a great way to build financial skills and build a good credit score. If you have a responsible teenager, consider helping them to open a low-limit credit card with a trust-worthy financial institution. I’d recommend have a joint account so that you can keep an eye on the activity and provide guidance. Teach your teen to use it for small expenses and to pay the bill in full each month. Encourage a mental relationship between income and spending. Good credit habits are a lifetime skill and will make your teen’s future years much smoother.
Your teen doesn’t need to have a job to develop credit, but I’d recommend holding off on the credit aspect until they’ve developed the responsibility to earn some income.
Once you have income, you have the ability to start sharing with others. Show your child how to select worthy recipients for their gifts, and develop their giving spirit. Not only is it good for your heart, but anecdotal evidence suggests that those who give generously find that good things come their way.
With summer job season coming, seize this opportunity to set your teen up for a lifetime of financial success. How awesome would that be?