By Rachel Ochman
Ask any group of college-bound kids what they’re looking forward to this April, and you may expect them to say spring break. Yet a growing number of students could have a different answer this year: their tax refunds.
Fifty-two percent of high-school students have gotten jobs to help shoulder the astronomical costs of tuition, according to a 2011 College Savings Foundation study. The same study indicates that 23% of high-school students saved more than $5,000 for tuition expenses, up from 19% in 2010.
With income comes 1040s. (If you’re a dependent who has earned more than $5,700 as someone’s employee, you have to file. The rules change a bit when it comes to unearned income, or if you’re self-employed.) Since the IRS now requires some of these kids to fulfill the grownup responsibility of filing taxes, they now qualify for the grownup perk of saving for retirement.
“It’s less uncommon than college students think to save for retirement, even at young ages,” says Stuart Ritter, a vice president and certified financial planner at T. Rowe Price.
The best retirement-savings option for a college-age student is a Roth IRA, says Ritter. Unlike traditional IRAs, savers make contributions with after-tax dollars. Yet Roth savers don’t have to pay taxes on the earnings. Because students most likely will be starting at a very low tax bracket—and withdrawing funds at a higher tax bracket later in life—it makes more sense to withdraw the money tax-free than to contribute pretax. Ultimately early savers will have more money to spend in retirement with a Roth, says Ritter.
To qualify to contribute to a Roth IRA, you need earned income that meets the contribution limits. If you’re single and under 50, you can make a full contribution of $5,000 until your modified adjusted gross income hits $107,000. That contribution amount phases out until your MAGI reaches $122,000. If you’re married, you can make the full contribution until your MAGI hits $169,000, with contribution phase-outs until $179,000. Some plans require a minimum initial contribution to open an account.
While not easy, the benefits of starting early are enormous. A 20-year-old saver who ferrets away $100 a month in an IRA earning 7% a year will have $379,000 at the age of 65, according to Ritter. Someone saving the same amount starting at age 30 will have only $180,000. (The late saver would have to contribute $211 a month to hit the same balance at 65.)
Readers, how old were you when you started saving for retirement? What savings advice would you give students?