Each month, I share a free newsletter about money with 904 other Millennial parents. We talk about how to turn your money into memories with your family.

Hi, I'm Kevin.

Hi, I'm Kevin. I write a free newsletter about money for 904 other Millennial parents. We talk about how to turn your money into memories.

The Power of a Roth IRA For Your Child

Financially Well

May 30, 2024

Earlier this morning, you may have changed your baby’s diaper. Or perhaps you packed a lunchbox for your school-age child.

Now, imagine that same child as a 22-year-old.

She’s about to start her first full-time, entry-level job. She’ll earn a decent salary, but she’s living in an expensive city. And maybe like you, she’s also making a student loan payment each month.

Between this morning and her early 20s, your child will make a little money along the way.

She may coach young athletes, mow lawns, babysit, or tutor other children. When that happens, the IRS will view the cash in her wallet as “earned income.”

But for once, this isn’t a tax headache.

These small paydays will create an opportunity for you to teach her about investing. And they’ll create an opportunity for her to experience compounding.

So together, you’ll open her first Roth IRA – while she’s still a child, even as young as 10-years-old. Eventually, she’ll appreciate your help. She’ll appreciate compounding, too.

Because your future 22-year-old might begin her adult life with more than $100,000 in retirement savings.

An IRA, or individual retirement account, is one of a few tax-advantaged investment accounts in the U.S. You may be most familiar with the 401(k) accounts that many employers offer.

The Roth IRA, in particular, gains its power from the timing of taxes. With a Roth, you don’t get a tax deduction in the year you contribute. Rather, you invest in the account after you’ve already paid taxes on that income.

But then you’re done. No more taxes for that account.

And over time, your Roth IRA contributions will grow with the market. Your investments will compound. Sure, your original contributions will grow.

But you’ll also generate new money directly from the previous gains that you earned.

Yet, we often fail at compounding.

It’s a notoriously tough concept for our brains to grasp. Compound growth is confusing. It’s abstract. And it’s slow.

Typically, we can’t see much change at all, often for years. Until, all of a sudden, the change becomes dramatic.

So what can we do in the interim? How can we stick with such an unfulfilling process?

Through the proof of concept that already exists. We can fight the urge to give up by learning from compounding that already has taken place elsewhere.

We can see compounding in human language.

Professional soccer player Romelu Lukaku, who grew up in Belgium, became bilingual at an early age.

First, he spoke French at home. Then, he added Flemish at school. And periodically, he would address his Congolese relatives in their native Lingala.

A Georgetown University study found that “bilinguals appear to learn new language more quickly than monolinguals.” Similarly, researchers at the University of Washington showed that, “Based on brain activity, people who live in communities where multiple languages are spoken can identify words in yet another language better than those who live in a monolingual environment.”

In April 2019, Lukaku became interested in playing for an Italian team. So he started watching Italian soccer matches on TV. By July, he could “have a conversation with anyone” in Italy. And when the season started in August, he insisted that his teammates address him in Italian.

Through this consistent, incremental exposure, Lukaku has learned eight different languages.

We can see compounding in nature.

Scientists have long suspected that ice previously covered the Earth. They have found “rock beds scraped down to thin layers.” And “huge boulders strewn in random locations.”

But dramatic amounts of snowfall didn’t cause the extensive ice. Instead, as Morgan Housel shares in The Psychology of Money:

The ice began “when a summer never gets warm enough to melt the previous winter’s snow. The leftover ice base makes it easier for snow to accumulate the following winter, which increase the odds of snow sticking around in the following summer, which attracts even more accumulation the following winter.

Perpetual snow reflects more of the sun’s rays, which exacerbates cooling, which brings more snowfall, and on and on. Within a few hundred years, a seasonal snowpack grows into a continental ice sheet…”

As glaciologist Gwen Schultz explains, “It is not necessarily the amount of snow that causes ice sheets, but the fact that snow – however little – lasts.”

This simple, small, and slow phenomenon has produced five different ice ages on Earth.

And we can see compounding in personal finance.

But often only if we look at an extreme example, like Warren Buffett.

As of 2019, Buffett’s net worth was $84.5 billion.

Yet, as Housel writes:

“Effectively all of Warren Buffett’s financial success can be tied to the financial base he built in his prepubescent years [editor’s note: he started at age 10] and the longevity he maintained in his geriatric years.

His skill is investing, but his secret is time.”

Buffett accumulated 99% of his wealth after his 50th birthday. He didn’t even have 96% of that money until he reached his mid-60s.

Investing for – and with – our children may make compounding more real to us.

When your child eventually makes some money, she’ll likely earn less than $14,600 in a year. That’s the standard tax deduction for a single filer in 2024.

And since this deduction exceeds your child’s income, she won’t owe any federal income taxes that year.

Now, a reminder about Roth IRA contributions: you usually pay taxes on that money before you invest in the account. But kids who earn less than the standard deduction won’t owe any income taxes.

So they get a much better deal than us adults. To paraphrase my colleague Meg Bartelt:

The money goes in tax-free!
The money grows tax-free!
And our children eventually can withdraw the money tax-free!

And the entire time, she gets investment gains on top of previous gains.

If you’ve ever read about compounding, the tone may have felt a bit condescending. “If only you had invested more money at age 22! No wonder you’re struggling to stay on track with your retirement savings.”

No mention of student loans, housing costs, or economic turmoil.

But even in ideal financial circumstances, “our brains,” personal finance author Ben Carlson writes, “aren’t made to think in exponential terms. We are linear thinkers.”

Compounding isn’t intuitive to us.

If we can envision our future 22-year-old, though, we may just remember to set up her first Roth IRA. And then she can show you just how powerful that exponential growth can be over time.

A Few Compounding & Child Roth IRA Resources For You

If you’re interested in the math behind compounding, check out Ben Carlson’s example.
If you want to learn more about how to properly open a custodial Roth IRA, check out Meg Bartelt’s explainer