Why Teenagers Should Save for Retirement (And How to Get Started)

As a teenager, the last thing I think about is retirement. After all, I am only sixteen, living at home with my parents, and still am a high school student! Almost all teenagers are the same way. We prefer buying the newest technology and fashion trends than putting them away towards our long-term future, especially considering how far away that future is. The average retirement age is between 61-64, which shows that teenagers have time. Moreover, history dictates that baby boomers typically started saving for their golden years at age 35, and Generation X began at a median age of 30. This begs the question: Why should teenagers start planning now?  

The Wonder of Compound Interest 

Albert Einstein claimed that “compound interest is the eighth wonder of the world,” and his assertion is correct. Using mathematics, we can let the numbers prove how powerful compound interest is. We can do so by setting up a hypothetical: 

Dave is 17 years old and living with his parents, earning $15 an hour during the summer while working a summer job as a lifeguard. Dave works 40 hours a week for the duration of the summer (10 weeks) and decides to take a break during the school year to focus on his classes. However, he informs his supervisor that he wants to return the following year to continue lifeguarding in the summer. The supervisor loves Dave because of his strong work ethic and happily agrees. Dave is a teenager who loves to spend and shop, but he has a clear budget and decides to save 50% of his income earned during the summer. 

If Dave follows his plan, he will have earned $12,000 over two years. However, Dave will have spent half of the money, but he still has $6,000 saved. If Dave invests this $6,000 in an investment fund that tracks a broad market index like the S&P 500, he will have earned just about 10% per year on his initial investment. Luckily for Dave, he has a lot of time for interest accumulation, as he will retire in about 45 years. By then, Dave will have roughly $435,000.  

According to a 2022 Survey of Consumer Finances, the average retirement savings for all families is $333,940. Therefore, if a teenager invests the amount of money Dave did from a summer job and never again, they will have more money than the average retiree. However, to maximize the effectiveness of compound interest, it is essential to begin interest accumulation as soon as possible. The bottom line is to start investing all the money you can now! 

Building Good Habits 

Building good habits may sound intuitive, but habits from adolescence carry over to adulthood. A study published by the National Library of Medicine perfectly illustrates this phenomenon. They claimed that behaviors like adequate exercise, sleep, and maintaining a healthy weight during adolescence promote higher levels of healthy behaviors throughout adulthood. 

Similarly, teenagers who develop the habit of saving money will have a much easier time when it comes to saving for their first down payment on a house, repaying student loans, and eventually saving up an education fund for their kids. Research proves this theory, as children who grew up with a savings account were more likely to hold “diverse asset portfolios and to accumulate more savings as young adults,” which sets them up better for their future.  

Despite the apparent value of saving while younger, as more compound interest accrues, people should still save money for fun experiences and some indulgence. Moreover, everyone has different goals for their desired lifestyle while retired, so people should adjust their plans accordingly. However, saving at a young age will develop the habits necessary for people to cater to their needs, and the maximum amount of compound interest will accrue. 

I am Interested in Starting Early, but How Exactly Do I Start? 

Although you may have heard about a 401k to finance retirement, opening a 401k without a full-time job or being a business owner is impossible. Instead, the easiest way to start saving money for retirement, especially for teenagers, is through a custodial Roth IRA. 

A Roth IRA, also known as a Roth Individual Retirement Account, provides the opportunity for tax-free growth and therefore is perfect for teenagers. If we circle back to our example of Dave, where $6,000 grew to $435,000 over 45 years, he can start withdrawing as soon as he is 59 and a half years old. The best part is that he will not have to pay a dime in taxes! The only difference between a custodial Roth IRA and a Roth IRA is that an adult is in charge of the account until you reach the age of 18 or 21, depending on the state you live in. 

Roth IRAs Seem Too Good to Be True, What’s the Catch? 

While if handled properly, there are no explicit downfalls of a Roth IRA, but there are a couple of rules.  

First, you must have earned money to contribute to the account. In the example of Dave, he is eligible because he earned money from his lifeguarding job. Moreover, Roth IRAs have a contribution limit depending on age. As of 2024, the limit for individuals under 50 is $7,000, and the limit for individuals 50 and older is $7,500. Despite these contribution limits, people should maximize their contribution to reap the benefits of a tax-free withdrawal.  

Another reason to start investing early in a Roth IRA is because one day, a person may not be eligible to depending on their income. As of 2024, individuals filing taxes must have a modified adjusted gross income of less than $161,000, and people filing taxes as a married couple must have a modified adjusted gross income of less than $240,000 to contribute to a Roth IRA. For some people, this means that the time they have to contribute to a Roth IRA is short, especially considering that income grows with age and experience. Therefore, to exploit the advantages of a tax-free withdrawal, I recommend investing early to allow for time for compound interest.  

I Now Have a Custodial Roth IRA, How Do I Invest? 

Investing should be treated seriously. Even if you are investing a small amount of money, making safe investments is essential, especially when something important like retirement is on the line. Teenagers without any investing experience should try to first invest with paper money on an online simulator. Even though virtual simulators like those on Investopedia use “fake money,” investors should make calculated decisions.  

Although portfolio management could seem like a fun experience to some people, many people choose a passive approach to avoid stress. In their case, they can hire a financial advisor or create a hands-free approach where they invest in a fund that tracks the broader market and wait for interest to accumulate. However, no matter which direction you choose, make sure to perform your due diligence! 

If you are a teenager reading this article, talk to your parents about setting up a custodial Roth IRA and explain the benefits of compound interest and building good habits. Finally, if you create an investment account, make informed decisions, and don’t be afraid to ask a trusted adult for help. Stay tuned for more investing content soon!