Saving regularly, beginning with the first money a student earns can swiftly become a habit. This habit will serve the student well, long into the future. But there are current benefits to the saving habit as well.
Benefits of a Roth IRA for a student
When a student saves money by contributing to a Roth IRA, an interesting thing occurs: since the majority of the earnings (if not all) are less than the taxable minimum, by putting the money in a Roth IRA, this money will never be taxed. This is to assume that the money is left in the Roth IRA until retirement or some other qualified distribution.
Because the Standard Deduction in 2018 for a dependent of another taxpayer is “the total earned income plus $350, up to $12,000”. So the student could earn up to $12,000 over the course of the year (from a summer job and perhaps part time jobs during the school year, for example) with zero taxes! And from this $12,000, the student could contribute up to $5,500 to a Roth IRA in 2018.
Of course, it may not be reasonable for the student to put aside so much of his or her earnings. After necessary expenses, some gas money, and a bit of “mad” money, maybe there’s only $500 or $1,000 left for savings. Any little bit can be a good start! It might be a good idea to set a specific percentage aside for long-term savings, like 10% of each paycheck, to get in the habit of paying yourself first. This is, as you might recognize, an excellent way to augment saving activities by making it a personal requirement of every dollar earned.
In addition to the “never to be taxed” factor, consider this: by comparison to a standard savings account, a Roth IRA for a student does not need to be considered as a source for FAFSA (financial aid) calculations. This is because the Roth IRA is a retirement account, and as such is not included in FAFSA reporting. For some students, this can make a difference in financial aid.
Being a retirement account, there are legal hindrances to early withdrawal – which might keep the temptation to withdraw at a minimum. This way, the savings habit can continue and returns can compound over a long period of time. That $500 or $1,000 saved this year can grow to an impressive sum over time. If $1,000 is set aside for a 20-year-old today and left alone at a modest average return of 5% per year, after 40 years it can build to more than $7,000. Continued saving will, of course, have a much more dramatic effect: if another $1,000 is set aside every year for those 40 years, it could grow to $137,000!