If child has earned income from either a full time or part time job, it is worth thinking about sheltering the income with an Individual Retirement Account(IRA).

The IRS will allow a child with earned income to open an IRA and make a contribution up to the extent of earned income not exceeding the annual limits established by the IRS which is $4,000 for tax year 2007.

If the young 16 year old child makes lets say $1,000 per year from newspaper rounds or temporary jobs bagging groceries, he is able to contribute to his own IRA to the extent of $1,000. Despite this amount being small, the long term impact of this $1,000 is substantial. Lets assume that the funds are invested in a diversified mutual fund growing at 8% per year.

Using the classical financial ratio, the magic of 72, the money will double every 9 years, (72 divided by growth rate of 8% = 9). So, by Age 61, without making any additional contributions, the value of the original $1,000 IRA investment just through tax-free compounded growth would result in approximately $32,000!!! The calculations below show you powerful impact of compounding!!

After 9 years:
The money would double to $2,000, the Child reached Age 25

After 18 years
The money would double to $4,000, the Child reached Age 34

After 27 years
The money would double to $8,000, the Child reached Age 43

After 36 years
The money would double to $16,000, the Child reached Age 52

After 45 years
The money would double to $32,000, the Child reached Age 61

Just imagine if the child makes annual contributions for 10 years! The value of the funds would be incredibly huge!

__________________
Find a CPA near you!

Ask TaxGuru Please refer to the legal disclaimer.