July 9, 2007

Roth IRA – not a great gift for a 16-year-old?

Posted in Saving for College, The Financial Aid Process at 8:15 AM by Joe From Boston

Hi folks, I’m back from vacation and back to finding you the best news, articles and interesting stories about the world of financial aid. Here’s one that might surprise people!

The Chicago Tribune has a great article about starting people saving young – namely that a Roth IRA for a 16 year old isn’t a great option for everyone.

Roth can be expensive gift for 16-year-old

Published July 8, 2007

Q. My wife and I are thinking about opening a Roth IRA [individual retirement account] for our 16-year-old son. I’ve paid attention, as you have suggested that small savings early in life can turn into million-dollar nest eggs. Is there any reason why we shouldn’t open a Roth IRA for our son?

A. If you were considering giving your son a Roth IRA as a college graduation gift, it would be a no-brainer. I’d applaud your decision — maybe even nominate you for a “Parent of the Year” award, for providing your son a tremendous head start on his financial future.For a 16-year-old, the question is more complicated. That’s because college costs lie ahead, and your son’s investments could make college more expensive for your family than they need to be.

That’s unfortunate, because a Roth IRA truly could make a remarkable impact on a 16-year-old’s future.

Just remember: You cannot put more money into a Roth than your son earns. But if you were to open a Roth IRA and put $4,000 in a mutual fund that invests in the total stock market, your son would likely amass more than $500,000 by retirement if the stock market grows at the 10 percent annual average it has historically. That sum is based on a one-time $4,000 investment into a total stock market index fund, and adding nothing more over the years besides the money that your son earns on the original $4,000 investment.

If you invested $3,000 for your son this year, and did the same thing again the next couple of years, he could amass about $1.3 million, even if he never added a cent of new money beyond his earnings in the stock market mutual fund.

When I have urged parents to do this in the past some have objected — saying children need to save on their own, rather than depend on a kindly parent or grandparent.

Often, however, early investments encourage — rather than discourage — saving. About half of people in their 20s skip contributing to 401(k) retirement savings plans at work because they don’t understand the power of compounding to grow small savings. But when people do start investing early and see paltry savings grow dramatically, they often become motivated to dig into their paycheck for a little extra to invest.

Those small amounts deliver huge benefits, especially when people start investing in their 20s. Investing just $5 a week can ultimately deliver over $200,000.

All of that potential aside, opening a Roth IRA for a 16-year-old, “may not be a good idea,” says Kalman Chany, author of “Paying for College Without Going Broke.”

That’s because some colleges will reduce financial aid for students who have any savings, even if they are in accounts like IRAs, which are designed for retirement savings.

If your son will attend a public college you probably don’t need to worry about this. Such colleges compute financial aid using a federal formula, and a form called the Free Application for Federal Student Aid, or FAFSA.

The formula allows low-income and moderate-income families to receive aid even if members have retirement savings. But each private college has its own rules. Many ask families to fill out a form called the PROFILE, and in it they must disclose any IRA or 401(k) savings a student has acquired, Chany said.

Some colleges may ignore the accounts. Others will, in effect, tell parents to use the student’s Roth IRA money to pay for college. That could mean grants — or free money — could be cut, and parents will have to dig deeper into their pockets to pay for college than they would otherwise.

With tuition at many private colleges running more than $42,000 a year — or about $168,000 for four years — most families need all the financial aid they can get. So it’s not worth taking a chance with a Roth IRA for a child about to attend college.

That’s unless your income is so high that financial aid seems out of the question. Chany said if your income is over $250,000 you probably won’t qualify for aid. Once your income crosses the $150,000 threshold your chances of obtaining financial aid start to diminish. Although circumstances vary, at public colleges it is difficult to obtain financial aid if your income is around $50,000 or higher.

You can read the entire article online at the Chicago Tribune.



  1. […] points out that state schools generally use the federal formula, while private schools might not: Roth IRA – not a great gift for a 16-year-old? « Student Loan Info for Parents But one thing that I think this author is missing is that if you invest $4000 in a Roth IRA and […]

  2. […] Original post by moniqueleonard […]

    • Steve M said,

      I don’t agree with the writer at all. He/she says “For a 16-year-old, the question is more complicated. That’s because college costs lie ahead, and your son’s investments could make college more expensive for your family than they need to be.” You are sending the youth absolutely the wrong message: “Don’t contribute to an IRA until you take care of your college expenses.” But everyone has expenses. The question is when should you get your IRA underway. The answer is “as soon as you have accumulated enough earned income to start one.” The secret to saving for retirement and building wealth is to quit making excuses for not doing so. Pay yourself first, then force yourself to live on what’s left. If you don’t pay yourself first, you will be making excuses for not doing so until you reach age 65 broke.

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