A first job can be an important rite of passage—whether your teen is working to purchase (or insure) a vehicle, to pay for entertainment expenses, or even to help fund college tuition, he or she is likely excited for the freedom and independence a job will provide. However, depending upon your teen’s personality and lifestyle choices, the funds earned may be used wisely or squandered before summer’s end. Read on to learn more about some ways you can encourage your teen to use his or her earned income to provide income and benefits far into the future.
Check tax withholdings
Before your teen receives a single paycheck, he or she will be required to fill out a W-4 form to specify the amount of federal and state income tax that will be withheld from his or her pay and remitted to the IRS and your state’s department of revenue (if your state has income taxes).
Unless your teen has dependents or lives on his or her own, it’s unlikely he or she will need to enter many exemptions (which generally lower the amount of income tax withheld from each paycheck). However, it’s worthwhile for your teen to fill out the exemption worksheet before submitting a W-4 form to ensure he or she is selecting the most appropriate withholding option. While receiving a hefty income tax refund after doing taxes next year can seem like a way to encourage involuntary savings, this practice essentially operates as providing the government with an interest-free loan until the following tax year. A better option is to have the correct amount withheld from each check and set up a dedicated savings plan.
Investigate online banking options
“Out of sight, out of mind” doesn’t just apply to interpersonal relationships—it can also help boost your savings rate. While having a checking or savings account at a local brick and mortar bank can help your teen learn to balance a checkbook (and allow him or her access to instant cash without paying an exorbitant ATM surcharge), this convenience and easy access can make it more difficult to save funds for the long term.
Opening an online savings account with a bank that doesn’t have local branches can allow your teen to periodically transfer savings to this account to render them more difficult to access. While online savings accounts are just as safe and secure as those available at brick and mortar banks, it can often take up to a week to transfer funds from an online account to a local checking or savings account, helping your teen stem impulse purchases and set aside long-term savings without putting a high “available” balance on his or her radar each time he or she visits the bank or makes a withdrawal from an ATM.
Consider opening a retirement account
Starting a retirement account in conjunction with beginning one’s first job may seem like overkill. owever, the true power of compound interest is demonstrated best through frequent (and early) investments. If your teen begins putting aside even a small amount of his or her earned income into a retirement investment that offers preferable tax treatment, he or she will enjoy increased financial flexibility later in life, perhaps even being able to retire earlier than planned or leave a bad job situation without a backup.
Unless your teen is skilled enough to earn more than $131,000 in his or her first year of work, he or she should qualify to open a Roth IRA. Roth IRA contributions are made post-tax, and all contributions and gains can be withdrawn tax-free in retirement, giving them decades to grow in the meantime. Another benefit to the Roth IRA that may serve your teen well is the account holder’s ability to withdraw contributions at any time without paying the penalty often assessed on withdrawals from other types of retirement accounts. This means that the funds your teen invests today could later be used for college, to pay for a wedding, or as a down payment on his or her first home.