Few things are as much a part of growing up in America as getting a summer job. And here's why most agree a summer job is a good thing to have as part of your coming of age:
You get a good introduction to the rest of your life, which more likely than not will involve a job — working for someone else. You learn about being on time, maintaining quality standards, and the many nuances of employment that can never really be taught in school.
It's usually an eye-opener to the reality adults live with, i.e., the need to get along with coworkers who aren't family and yet have control over your life in ways that often are uncomfortable. You also learn that every job usually has rules you have to follow, even though they may appear to be irrational or unduly strict.
It's a terrific opportunity to get a feel for different types of careers too. Do you like retail or construction, being a park ranger or an accountant? Summer jobs can help you make more informed career choices and, therefore, make better decisions about college education.
But, for most kids, the number one reason to get a summer job is … the money!
At Get Rich Slowly, we know that saving or investing for the future is essential. But since the days where teens were enlisted to work the harvest, few generations have had such a unique opportunity to secure their future. These days, using the same investment method available to their parents, teens are uniquely positioned to make at least $150K from their summer jobs during high school and more than a million if they continue to work and save modestly on through college.
I don't think anybody keeps statistics on these kinds of things, but my guess would be that more than 90 percent of summer job workers do not even give the question of whether they should deposit part of their income into an Individual Retirement Arrangement (IRA) a single thought.
Just for fun
I thought it would be interesting to check. So I asked a few kids in my neighborhood (totally scientific, I know): “Hey, do you think you should put part of your summer pay into an IRA?”
Most of them looked quizzically at me, like I was speaking a foreign language or I had just returned from a mission to Pluto.
Not one even knew what an IRA was! Not a single one! I had to explain it as simply as I could. Once they understood that it entailed giving up some of their hard-earned pay, none even wanted to know what an IRA is. My guess — and it is just a guess — is that anything separating them from their money which doesn't involve immediate gratification is just unspeakably evil.
Another wild guess: Their parents did not sit them down and tell them how wonderful a Roth IRA, or any form of savings, can be.
I then asked a parent or two if they knew whether their kids considered putting some summer job pay into an IRA. Given my discussions with the teenagers I spoke to, I had a suspicion as to what their parents' answers would be, and they didn't disappoint: Not one even considered mentioning the option to their kids. (I think it's because they never did it growing up.)
They were as surprised as the kids at the very notion of opening an IRA at such a young age. “Is it even possible?” asked one of the parents.
Age (and other) qualifications for IRA accounts
There is no minimum age qualification to open either a traditional or Roth IRA. All your teenager needs is taxable earned income. (In other words, rich kids earning dividends and interest on trust funds do not qualify.)
Taxable earned income includes wages, tips, and earnings from self-employed income. (Read that as: lemonade stand, paper route, babysitting, etc.) There is a limit to the amount they can contribute to an IRA, and that is the amount of income they earned. (In other words, they can't earn $1,000 and put Grandma's gift of $3,000 into an IRA.)
There is another qualification which might not appear obvious at first glance: In order to open an IRA, your teen has to file a tax return.
Filing tax returns
If the notion of a teen filing a tax return fills you (or them) with dread and unprintable language, think again. Technically, your teenager doesn't have to file a tax return if she or he earned less than the standard deduction for singles ($6,200 in 2014, $6,300 in 2015). Not too many summer jobs pay that much, which is why filing taxes rarely falls within the orbit of pre-adults … and everyone seems happy about that.
However, teenagers may actually benefit from filing taxes individually for several reasons:
If their employer pays (and deducts) payroll taxes (e.g., if they use a payroll system), chances are there might be a tax refund waiting for them if they file. And that's just cash in their pocket … but they have to file.
What better way to educate your children about the other of the only two sure things in life than by teaching them with hands-on experience? Most people learn best from doing, and helping kids file taxes while they are still in the home could be a valuable experience for them (especially if refunds are involved).
It might not be the most efficient reasoning, but learning to file taxes at an early age also brings home the value of tax-advantaged investing (things like an IRA or 401(k) plan). Anyone who has filed a tax return has looked longingly at that money and wondered, “Hmm… Is there a way I could keep a little more of that for myself?” Until they have asked that question, it's not likely they will really grasp the benefits of tax-preferred retirement investment plans. In turn, that might very well become a reason why they wait too late to get started.
Whichever way you look at it, getting your child to file their taxes has more benefits than most people think. Oh, and then there's the benefit of being able to put a little money away into a Roth or traditional IRA.
Why would that be such a good thing?
How summer jobs can amount to a million dollars
If we're talking summer jobs for high schoolers, it's probably fair to assume that your teenager will not be paying much in the way of income taxes. Therefore, a Roth IRA seems the obvious choice because the contributions are made after tax — and the withdrawals in retirement are tax-free.
Let's use that assumption and see how the math works out. If your son or daughter works three months for each of their four high-school years, and they deposit $250 per month in an IRA (i.e., $750 per year) — and assuming the money is invested in a simple S&P 500 low-cost index fund — when they reach retirement age, the balance will amount to $150,000! Now, in my book that is making high school pay!
And because it's from a Roth IRA, that amount is tax free!
Odds are any given teen will squawk that $250 a month is a big chunk out of what they make. But just look at how big it becomes when they reach age 65 (again, tax-free).
Should they add similar, modest contributions from their earnings in college, it can easily put the terminal value over a million dollars — tax-free. (I can't help repeating that!)
The extraordinary power of compounding
How does such a small amount ($250 per month for three months, done only for four years) accumulate to $150,000? It's called the extraordinary power of compounding, interest on interest. The miracle of compounding requires time more than money, and isn't that exactly what teens earning entry-level money have?
If someone had told me this when I was working high school summer jobs, I cannot imagine how much better off I would be today. If parents would take the time to explain just this one simple concept to their teens, how much better off will those kids be?
What plans do your teenagers have for their summer-job income? Have you discussed opening a Roth IRA with your teen? Is this doable in your teenager's situation?
Author: William Cowie
William Cowie spent 30 years in senior management (CFO/CEO) before retiring. He has a bachelor's, a master's, and a partial doctorate in management and strategy. Author of the book “The Four Seasons of the Economy,” William also assists medium-sized businesses in the use of the Four Season Strategy to help them capitalize on economic cycles. He runs two blogs: Bite the Bullet Investing (investing) and Drop Dead Money (the economy) and writes for several other blogs in addition.