Author Topic: 18 y/o son: Roth vs. Traditional IRA  (Read 5048 times)

mynewchoice

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18 y/o son: Roth vs. Traditional IRA
« on: January 31, 2017, 02:18:10 PM »
Greetings all,

My 18 y/o son, who is a senior in high school, received his W2 yesterday and had an eye-opening realization--he earned approximately $16,000 last year, and he spent a good portion of that on things he doesn't even remember.  He certainly didn't "blow" it all, because he bought a car (2003 Nissan 350z for $6,000--Mrs. MNC and I paid for it upfront and he paid us back approximately $3,000 so far) and he has saved approximately $3,000 in his savings account. He also pays me every month for his car insurance and cell phone, but what he doesn't know is that I am stashing those payments for him and plan to give it to him after he finishes school.

With that said, he and I talked about how he could have paid off his car, met his goal of having $5,000 in emergency / liquid savings and still have had fun money left over.  I have talked to him previously about starting a retirement account, but he is one that struggles to look one month ahead let alone many years ahead.  I regularly bring up discussions about people here retiring really young and not having to worry about a job, hoping some of it sinks in--and last night as we talked about his W2, we started discussing a retirement account again.

He liked the idea of the Traditional IRA because it would reduce his taxable income and give him a bigger refund, or bonus in his mind.  As I think about it, I would tend to direct him towards a Roth IRA now at this age when his taxable income is lower.

I've read pros and cons of both, so I thought that I would come here and solicit some feedback from people that have either been in this situation with their children or would just like to share insight based on your own experiences.  Right now he is focusing on getting his savings up to the $5,000 target but he will be able to do an initial deposit of $1,000 into an IRA, which is still the minimum for quite a few places I believe, but then he would ideally send a conservative amount on a monthly basis as an automatic transfer with potential for periodic transfers of larger amounts.  His earnings do fluctuate as his job is PT but he picks up more hours during the summer, school breaks, and on weekends.

Other than reaching my own FIRE date, there are not many things that would make me happier than to see both of my boys (his brother is 15) be able to be FIRE at as early an age as possible so I want to make sure that I am giving the best guidance to him.  If I have left out any pertinent details, please let me know.

tyort1

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Re: 18 y/o son: Roth vs. Traditional IRA
« Reply #1 on: January 31, 2017, 02:23:34 PM »
I tend to go toward traditional.  Think about it - we salivate over a 10% return in the market.  But doing a Traditional IRA gives you a 10% gain (or more) immediately.  Unless he pays less than 10% in taxes???

La Bibliotecaria Feroz

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Re: 18 y/o son: Roth vs. Traditional IRA
« Reply #2 on: January 31, 2017, 02:25:45 PM »
Roth offers a young person more flexibility, if that's desirable. I used mine to buy a house.

mynewchoice

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Re: 18 y/o son: Roth vs. Traditional IRA
« Reply #3 on: January 31, 2017, 02:49:51 PM »
Roth offers a young person more flexibility, if that's desirable. I used mine to buy a house.

That is a good point and one that I am putting value in given his age and inexperience in saving for retirement.  When he had first talked to me about investing in stocks (which I told him index funds are the way to go) about a year ago, his vision was to make short-term gains so he would have more money to invest in modifications to his car.  With the Traditional IRA, taking that money back has penalties however that can also be a deterrent to thinking the money is there to just take out and spend in a year or two if the mood strikes him.

SeattleCPA

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Re: 18 y/o son: Roth vs. Traditional IRA
« Reply #4 on: January 31, 2017, 03:01:49 PM »
I really think Roths are way, way overrated. See here and here, for example...

http://evergreensmallbusiness.com/are-roth-iras-and-roth-401ks-really-a-good-deal/

http://evergreensmallbusiness.com/worst-case-scenarios-for-roth-style-accounts/

Further, most people don't ever save enough to actually need to worry about taxes in retirement. (You'd need to be in the 90th percentile basically...)

And when you look at the rate differential between today and tomorrow, usually the traditional wins.

Your son's situation, however, is one of the few cases where I think a Roth makes good sense. I'd say go for it.


GizmoTX

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Re: 18 y/o son: Roth vs. Traditional IRA
« Reply #5 on: January 31, 2017, 03:08:45 PM »
Do a trial tax return using each form of IRA. At his current income, I doubt there will be much difference.

DS started funding his IRA while working summers in high school. We advised him to go Roth, because it will never be taxable, doesn't require mandatory distributions (age 70+), & the principal can be tapped penalty free if necessary. This eased his mind because he had problems with the idea that his money was tied up for decades. On the other hand, young people need to understand that once tapped, a withdrawal can never be replaced, so its compounding power is gone forever. DS maxed his IRA contribution each year before buying anything else. He is now 23 & has about $70K saved, including his IRA, with no debt. DS will be graduating with a masters degree & starting his first full time job this summer that will likely exceed the Roth wage limit in a few years, so contributing to his Roth while young was critical for him. Even when he can no longer contribute to it, it will continue to grow tax free.

Indexer

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Re: 18 y/o son: Roth vs. Traditional IRA
« Reply #6 on: January 31, 2017, 03:29:16 PM »
For someone who is older with more income: let's debate it.

For someone who is very young with very little income: Roth. Roth. Roth.

With that income he will likely be in the 10-15% bracket, and his effective rate might be even lower. Let's face it, he isn't paying a lot in taxes. Why take a tax deduction on your almost non-existent taxes today so that you can pay more taxes in retirement?

With the Roth you pay minimal taxes now so you NEVER pay taxes again. I would gladly pay a 10% tax now to never have to pay taxes on that money ever again!

Other consideration, he is young, 40-50 years of growth in an aggressive investment, and then never paying taxes on that... I'm salivating at the thought!

I tend to go toward traditional.  Think about it - we salivate over a 10% return in the market.  But doing a Traditional IRA gives you a 10% gain (or more) immediately.  Unless he pays less than 10% in taxes???

You realize you eventually pay taxes on it right? Possibly a lot more than 10%.

sparkytheop

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Re: 18 y/o son: Roth vs. Traditional IRA
« Reply #7 on: January 31, 2017, 04:09:35 PM »
My son is 19, college full-time, part time work.  He's going to be opening a Roth while he has the extremely small taxes.

Also, for some of my younger coworkers with a lot of deductions (mortgage, a few kids), Roth has really been the way to go, since their taxes are so low right now.  The 5% match they get goes into a traditional IRA.

mynewchoice

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Re: 18 y/o son: Roth vs. Traditional IRA
« Reply #8 on: January 31, 2017, 04:33:46 PM »
Awesome feedback, thank you everyone!

@GizmoTX, great idea to run a trial tax run for each scenario to see exactly what the difference will be.

And to ease his concerns about losing out on any additional tax refund that he would get with the Traditional, I will personally add that difference to his Roth contribution and sweeten the pot by also paying him that difference cash in hand to acknowledge his effort to invest in his future.  Some might frown on that part but I view it as a small cost to get him started on a path to investing for his future, particularly since he has always been more of a spender.

robartsd

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Re: 18 y/o son: Roth vs. Traditional IRA
« Reply #9 on: January 31, 2017, 04:42:51 PM »
For federal income tax, as a dependent, his max standard deduction is $6,300, so his taxable income (without tIRA) is about $9,700. For single filers 10% bracket goes up to $9275, so about $425 would be taxed at 15%. I'd say teach him to really optimize: use tIRA to eliminate the 15% tax but max out the 10% bracket. Put remaining savings in a Roth IRA.

AlmstRtrd

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Re: 18 y/o son: Roth vs. Traditional IRA
« Reply #10 on: January 31, 2017, 04:59:21 PM »
Our 19-year-old daughter had her first job in 2016 and made about $3,300. We've set up a Roth for her with her contributing what she can and me matching it. So far we are at $2,500 total and she is really agonizing about parting with another $400. I keep telling her that people rarely get a 100% return on their money. Just trying to get her started early and also get her used to the idea of matching funds in a 401(k).

But I also like the idea that if a good business idea presents itself when she is out of college, she would be able to tap much of the Roth funds.

RangerOne

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Re: 18 y/o son: Roth vs. Traditional IRA
« Reply #11 on: January 31, 2017, 05:35:44 PM »
Have to agree its hard to beat the flexibility of a Roth. Especially when your tax burden is almost non-existent. I would for the sake of knowing see how much more would be saved per year with the pre-tax IRA.

But at age 19 I think the beauty of the Roth is that if it grows very large by theirs 30's and they determine they wont need the Roth for retirement it could act as a huge bolster to buying a home.

I don't think most would use the Roth as an Emergency resource but it is a real option, that doesn't exist with an IRA.

The only pro I can see with the IRA is slightly hire contribution rate, and it is highly likely to actually be saved and not get pillaged before retirement.

robartsd

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Re: 18 y/o son: Roth vs. Traditional IRA
« Reply #12 on: January 31, 2017, 05:38:21 PM »
Have to agree its hard to beat the flexibility of a Roth. Especially when your tax burden is almost non-existent. I would for the sake of knowing see how much more would be saved per year with the pre-tax IRA.

But at age 19 I think the beauty of the Roth is that if it grows very large by theirs 30's and they determine they wont need the Roth for retirement it could act as a huge bolster to buying a home.

I don't think most would use the Roth as an Emergency resource but it is a real option, that doesn't exist with an IRA.

The only pro I can see with the IRA is slightly hire contribution rate, and it is highly likely to actually be saved and not get pillaged before retirement.

I count my Roth IRA contributions (not making any more) as emergency fund. This helps me justify contributing more to my traditional retirement accounts now.

Ramparts

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Re: 18 y/o son: Roth vs. Traditional IRA
« Reply #13 on: January 31, 2017, 05:46:15 PM »
Is he filing his own tax return? (As single, presumably). And are you taking the exemption for him on your return or is he applying it to his own return?

Depending on the answers to those questions, the numbers might change around a lot. But you should also definitely look into the saver's credit on his return. It's possible that even if he contributes to a Roth, the saver's credit will wipe out any tax owed, meaning he'll pay $0 in federal taxes and be able to max out a Roth IRA for the year. If he's in this situation, going for a Traditional IRA would offer no benefit today (since the tax liability would still be $0) at the expense of tomorrow (paying taxes when the money is finally withdrawn). If the credit isn't enough to completely eliminate the tax liability, you may also want to look into doing just enough in a Traditional IRA to have no tax liability, and then put the remainder in Roth.

mynewchoice

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Re: 18 y/o son: Roth vs. Traditional IRA
« Reply #14 on: February 01, 2017, 05:03:40 AM »
Is he filing his own tax return? (As single, presumably). And are you taking the exemption for him on your return or is he applying it to his own return?

Depending on the answers to those questions, the numbers might change around a lot. But you should also definitely look into the saver's credit on his return. It's possible that even if he contributes to a Roth, the saver's credit will wipe out any tax owed, meaning he'll pay $0 in federal taxes and be able to max out a Roth IRA for the year. If he's in this situation, going for a Traditional IRA would offer no benefit today (since the tax liability would still be $0) at the expense of tomorrow (paying taxes when the money is finally withdrawn). If the credit isn't enough to completely eliminate the tax liability, you may also want to look into doing just enough in a Traditional IRA to have no tax liability, and then put the remainder in Roth.

He files his own return but I still claim him as a dependent on my tax return, or at least I did last year.  He had worked in 2015 and had a tax return last year as well, but his income was very small so we had not contemplated these various options.

teen persuasion

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Re: 18 y/o son: Roth vs. Traditional IRA
« Reply #15 on: February 01, 2017, 05:48:47 AM »
Is he filing his own tax return? (As single, presumably). And are you taking the exemption for him on your return or is he applying it to his own return?

Depending on the answers to those questions, the numbers might change around a lot. But you should also definitely look into the saver's credit on his return. It's possible that even if he contributes to a Roth, the saver's credit will wipe out any tax owed, meaning he'll pay $0 in federal taxes and be able to max out a Roth IRA for the year. If he's in this situation, going for a Traditional IRA would offer no benefit today (since the tax liability would still be $0) at the expense of tomorrow (paying taxes when the money is finally withdrawn). If the credit isn't enough to completely eliminate the tax liability, you may also want to look into doing just enough in a Traditional IRA to have no tax liability, and then put the remainder in Roth.

He files his own return but I still claim him as a dependent on my tax return, or at least I did last year.  He had worked in 2015 and had a tax return last year as well, but his income was very small so we had not contemplated these various options.

Sorry to be the bearer of bad news, but he won't be eligible for the Saver's credit.  Students are not eligible.  Dependents are not eligible, either.

Did he have any withholdings?  If so, his taxes may already be "paid".

DK

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Re: 18 y/o son: Roth vs. Traditional IRA
« Reply #16 on: February 01, 2017, 06:32:48 AM »
at that low of an income. roth all the way. he'll likely never be in that tax bracket again.

With being able to start that early and have compounding on his side, I might suggest helping him max it out so it can build over the years, or maybe 'match' his deposits.


talltexan

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Re: 18 y/o son: Roth vs. Traditional IRA
« Reply #17 on: February 01, 2017, 08:47:03 AM »
If income now > eventual expenses in retirement...you should put money in traditional IRA.

If income now < eventual expenses in retirement...Roth. Totally!

mynewchoice

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Re: 18 y/o son: Roth vs. Traditional IRA
« Reply #18 on: February 01, 2017, 08:51:34 AM »
Sorry to be the bearer of bad news, but he won't be eligible for the Saver's credit.  Students are not eligible.  Dependents are not eligible, either.

Did he have any withholdings?  If so, his taxes may already be "paid".

Yes, he had approximately $1,300 in federal, just under $600 in state if I remember correctly.

mynewchoice

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Re: 18 y/o son: Roth vs. Traditional IRA
« Reply #19 on: February 01, 2017, 08:56:06 AM »
at that low of an income. roth all the way. he'll likely never be in that tax bracket again.

With being able to start that early and have compounding on his side, I might suggest helping him max it out so it can build over the years, or maybe 'match' his deposits.

I am giving that some thought, as I have always tried to give them matches to help encourage the habit of saving.  We talked it through a little last night and he is still a little too focused on the immediacy of things and thinking about how he can grow his money in the short-term so he has more money to put into his car modifications.  I am encouraging him to at least start small on a Roth and maybe that match from me would be enough to seal the deal.

robartsd

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Re: 18 y/o son: Roth vs. Traditional IRA
« Reply #20 on: February 01, 2017, 09:03:23 AM »
Remember that once the funds are put into his IRA he has full control of the money. If you match his Roth contribution, that's an instant 100% return that he could take out and spend modifying his car.

tyort1

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Re: 18 y/o son: Roth vs. Traditional IRA
« Reply #21 on: February 01, 2017, 09:09:04 AM »
I'm not the OP, but I did rec a traditional IRA at the top of the thread.  You guys have convinced me that the Roth is better, and I learned some new stuff.  Thanks!

Ramparts

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Re: 18 y/o son: Roth vs. Traditional IRA
« Reply #22 on: February 01, 2017, 09:38:05 AM »

Sorry to be the bearer of bad news, but he won't be eligible for the Saver's credit.  Students are not eligible.  Dependents are not eligible, either.


Oh, I wasn't aware of that! Thanks for the correction.

teen persuasion

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Re: 18 y/o son: Roth vs. Traditional IRA
« Reply #23 on: February 01, 2017, 12:20:25 PM »
Sorry to be the bearer of bad news, but he won't be eligible for the Saver's credit.  Students are not eligible.  Dependents are not eligible, either.

Did he have any withholdings?  If so, his taxes may already be "paid".

Yes, he had approximately $1,300 in federal, just under $600 in state if I remember correctly.

Sounds like he'll still get ~$300 fed refund then.  No idea about your state.

WallStreetPhysician

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Re: 18 y/o son: Roth vs. Traditional IRA
« Reply #24 on: February 01, 2017, 03:56:39 PM »
Greetings all,

My 18 y/o son, who is a senior in high school, received his W2 yesterday and had an eye-opening realization--he earned approximately $16,000 last year, and he spent a good portion of that on things he doesn't even remember.  He certainly didn't "blow" it all, because he bought a car (2003 Nissan 350z for $6,000--Mrs. MNC and I paid for it upfront and he paid us back approximately $3,000 so far) and he has saved approximately $3,000 in his savings account. He also pays me every month for his car insurance and cell phone, but what he doesn't know is that I am stashing those payments for him and plan to give it to him after he finishes school.

With that said, he and I talked about how he could have paid off his car, met his goal of having $5,000 in emergency / liquid savings and still have had fun money left over.  I have talked to him previously about starting a retirement account, but he is one that struggles to look one month ahead let alone many years ahead.  I regularly bring up discussions about people here retiring really young and not having to worry about a job, hoping some of it sinks in--and last night as we talked about his W2, we started discussing a retirement account again.

He liked the idea of the Traditional IRA because it would reduce his taxable income and give him a bigger refund, or bonus in his mind.  As I think about it, I would tend to direct him towards a Roth IRA now at this age when his taxable income is lower.

I've read pros and cons of both, so I thought that I would come here and solicit some feedback from people that have either been in this situation with their children or would just like to share insight based on your own experiences.  Right now he is focusing on getting his savings up to the $5,000 target but he will be able to do an initial deposit of $1,000 into an IRA, which is still the minimum for quite a few places I believe, but then he would ideally send a conservative amount on a monthly basis as an automatic transfer with potential for periodic transfers of larger amounts.  His earnings do fluctuate as his job is PT but he picks up more hours during the summer, school breaks, and on weekends.

Other than reaching my own FIRE date, there are not many things that would make me happier than to see both of my boys (his brother is 15) be able to be FIRE at as early an age as possible so I want to make sure that I am giving the best guidance to him.  If I have left out any pertinent details, please let me know.

The Roth is definitely the correct financial answer. If you're generous and have the financial means, you could give him the amount of the tax break in cash as a bonus for working so hard and saving so early in life.

AlmstRtrd

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Re: 18 y/o son: Roth vs. Traditional IRA
« Reply #25 on: February 02, 2017, 05:29:24 AM »
Upthread I suggested that you maybe put matching funds into a Roth for your son (which is what we are doing for our daughter until she is finished with four years of college).

One question though that might throw a wrench into the works...

Is your son planning to attend college? My understanding is that student earnings and assets are weighted more heavily than parents' earnings and assets on the FAFSA. In other words, if a prospective college student makes "too much" money (say above $7,000 or $8,000), much of each additional dollar is then potentially "taken" by the college (meaning that the student is likely to receive less in grant money).... which may tilt your thinking back toward a traditional IRA.

Obviously do your own research on this and I'm happy to have others on here shoot this suggestion full of holes. I'd hate it if I am actually correct about this as working and saving are awesome habits/attributes for a young person.


seattlecyclone

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Re: 18 y/o son: Roth vs. Traditional IRA
« Reply #26 on: February 02, 2017, 08:58:44 AM »
You're right that the FAFSA does weigh student earnings and assets more heavily than parental earnings and assets. However the FAFSA doesn't count retirement accounts don't count as assets for students or parents. Furthermore the IRA deduction is added back into income for FAFSA purposes, so there's no difference on the income side either.

But I might suggest moving the cash savings account into the Roth IRA if your kid wasn't planning to max out his 2016 contributions otherwise. That would shield it from financial aid while not affecting the availability of that cash in a real emergency.

Rubic

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Re: 18 y/o son: Roth vs. Traditional IRA
« Reply #27 on: February 02, 2017, 09:34:54 AM »
Upthread I suggested that you maybe put matching funds into a Roth for your son (which is what we are doing for our daughter until she is finished with four years of college).

This is what I'm doing with my nieces and nephews.  I'll match to either a Roth or Traditional
IRA, but at this stage in their lives, a Roth makes more sense for their part-time income.

teen persuasion

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Re: 18 y/o son: Roth vs. Traditional IRA
« Reply #28 on: February 02, 2017, 06:52:25 PM »
Upthread I suggested that you maybe put matching funds into a Roth for your son (which is what we are doing for our daughter until she is finished with four years of college).

One question though that might throw a wrench into the works...

Is your son planning to attend college? My understanding is that student earnings and assets are weighted more heavily than parents' earnings and assets on the FAFSA. In other words, if a prospective college student makes "too much" money (say above $7,000 or $8,000), much of each additional dollar is then potentially "taken" by the college (meaning that the student is likely to receive less in grant money).... which may tilt your thinking back toward a traditional IRA.

Obviously do your own research on this and I'm happy to have others on here shoot this suggestion full of holes. I'd hate it if I am actually correct about this as working and saving are awesome habits/attributes for a young person.

Dependent student earnings are assessed at a higher rate: 50% of earnings over ($6420 + fed tax paid + FICA + a state fudge factor).  Then assets (does not include retirement accounts) at 20%.  So transferring savings to an IRA of either type is advantageous.

It always seemed to me that the FAFSA penalized students who earned before college and saved it for college expenses: 50% of your income PLUS 20% of your savings that came from those earnings.

Metric Mouse

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Re: 18 y/o son: Roth vs. Traditional IRA
« Reply #29 on: February 03, 2017, 01:24:50 AM »
I'm not the OP, but I did rec a traditional IRA at the top of the thread.  You guys have convinced me that the Roth is better, and I learned some new stuff.  Thanks!
Yes, this is one of the clear-cut cases when a Roth probably makes the most sense out of those two options.

robartsd

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Re: 18 y/o son: Roth vs. Traditional IRA
« Reply #30 on: February 03, 2017, 09:28:24 AM »
It always seemed to me that the FAFSA penalized students who earned before college and saved it for college expenses: 50% of your income PLUS 20% of your savings that came from those earnings.
Yes, I don't like how FAFSA looks at past income, and they've made it worse by looking at older income (so that it can be filed in the Fall and still be based on a past tax return). Any student whose income in the year they go to school is significantly less than their income in the tax year the FAFSA looks at should contact their school's financial aid office ask for a review. For a student who worked full time for 2+ years after graduating high school, then decides to go to a four year college, the only year where FAFSA's income information is likely relevant is their last year. If they worked only 2 years, their first year in college FAFSA would see half a year of income after high school; their second year FAFSA would see a full year of income; their third year FAFSA would see about 8 months of income prior to starting school. In the last of the four years FAFSA would finally see an income pattern compatible with being in school.

seventytimes7

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Re: 18 y/o son: Roth vs. Traditional IRA
« Reply #31 on: February 03, 2017, 09:49:12 AM »
My parents started a Roth IRA for me when I was about this age, when I was in a similar situation making good money for my age, but not saving any. They also matched dollar for dollar. That match was a great incentive for me to put money into that account. Since it looks like you already saving some of his "payments" to you, perhaps you can use that as an  incentive instead of the "tax bonus."

I'd agree with everyone here that Roth is the way to go right now.

talltexan

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Re: 18 y/o son: Roth vs. Traditional IRA
« Reply #32 on: February 06, 2017, 07:17:00 AM »
I wasn't able to fully fund my Roth during the early years (basically ages 21-28), when I was averaging only about $1200/year.

I'm still wayyy ahead of my wife (who only started one at age 28) because of those early years. And she's a better investor than I am.

DailyGrindFree

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Re: 18 y/o son: Roth vs. Traditional IRA
« Reply #33 on: February 06, 2017, 07:38:28 AM »
Roth is the way to go in this case. +1 for Roth.

mynewchoice

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Re: 18 y/o son: Roth vs. Traditional IRA
« Reply #34 on: February 07, 2017, 05:08:54 AM »
One question though that might throw a wrench into the works...

Is your son planning to attend college? My understanding is that student earnings and assets are weighted more heavily than parents' earnings and assets on the FAFSA. In other words, if a prospective college student makes "too much" money (say above $7,000 or $8,000), much of each additional dollar is then potentially "taken" by the college (meaning that the student is likely to receive less in grant money).... which may tilt your thinking back toward a traditional IRA.

Great point, and thanks for raising this as something to consider.  He is going to trade school so our plan right now is to apply for various scholarships and anything that is not covered by scholarships will be paid for out of our college savings.