Convert graduation gift checks to Roth IRA

by Center for Personal Finance editors

MCLEAN, Va. (7/25/06)--It's the gift that keeps on giving. Persuade high school graduates to use some of those graduation gift checks for a Roth IRA, and the investment will pay dividends for the rest of their lives (USA Today July 18).

The Roth IRA is a powerful tool, particularly when started at a young age. If an 18-year-old high-school senior starts a Roth IRA with $1,000, that investment will grow--tax-free--to more than $23,000 at age 72, assuming no additional contributions and an average annual return of just 6%. However, if the graduate contributes a modest $600 a year for those 54 years, under the same scenario, the investment would be worth around $245,000.

Know the rules:

Although there's no age requirement to start a Roth IRA, anyone (including a child) must have earned income from a job. Investment income, allowances and money earned from chores don't count.

You must earn as much as you contribute to a Roth IRA. The current contribution limit is $4,000, or the total amount of earned income, whichever is less.

You won't get a tax deduction for contributing to a Roth IRA, but your earnings grow tax-free.

You can withdraw the amount of your initial contribution--that's principal, not earnings--at any time without incurring penalties or taxes. And after five years, you can withdraw up to $10,000 in earnings towards the purchase of a first home without paying taxes or early-withdrawal penalties.

Who can provide funds for the contribution? Anyone--parents, grandparents, aunts and uncles, or any other person. So instead of a gift certificate or gift card for graduation, birthdays, or special holidays, consider giving funds for a Roth IRA. The young recipient may not fully appreciate it now, but in 30 or 40 years, that small gift may turn into a significant part of their investment portfolio.