— Drew

Thanks for the question, Drew.

That family paid no tax because tax is calculated on taxable income, not gross income (which we covered in this article: Deductions and Credits).

In 2025, the standard deduction for a married couple is $31,500. That reduces their taxable income from $100,000 to $68,500.

Since $68,500 is below the $96,700 threshold for the 0% long-term capital gains rate, all of their income is taxed at 0%.

In fact, they could earn significantly more and still pay no federal tax.

Assuming no other income, they could have up to $157,533 in long-term investment gains and still owe $0.

Here’s why:

Taxable income:
$157,533 − $31,500 = $126,033

The first $96,700 is taxed at 0%.

The remaining $29,333 is taxed at 15%:
$29,333 × 15% = $4,400

So their total tax is $4,400.

But this family has two young children.

Each qualifies for a $2,200 child tax credit, for a total of $4,400.

That credit fully offsets their tax, so they owe $0.

The 0% rate for long-term investment gains has only been around since 2008, but anyone can make use of it.

We covered different income types and how each is taxed in this article: Income Types.

They’re due tomorrow — April 15.

Today’s article is brief — 4 charts showing the Federal tax owed by 8 families.

The only differences are how much they earn — and how they earn it.

Each family is married with two young children and takes the standard deduction.

The first two families each earn $100,000 — one from wages, the other from long-term investment income.

The next two families each earn $200,000.

The next two families each earn $400,000.

The next two families each earn $800,000.

Observations

Long-term investment income can be taxed as low as 0% (up to $96,700 in 2025 for married couples).

The amount you pay in taxes depends not just on how much you make — but how you make it.

Wage income is subject to Social Security and Medicare taxes. Investment income is not.

Many discussions about “taxing the wealthy” focus on wage tax brackets. But higher-wealth households often earn a significant portion of their income from investments.

As a result, very wealthy households can have lower effective tax rates than middle-income households earning wages.

This is one of the reasons the wealth gap has widened over time.

But they don’t get the same deal.

Adam qualifies for a 4.9% interest rate.
Ryan? 13.9%.

The only difference?

Their credit scores.

What Is a Credit Score?

A credit score is a number lenders use to decide how risky it is to lend you money.

It’s based on how you’ve handled credit in the past:

• Have you paid your bills on time?

• Do you borrow a lot?

• Have you missed payments?

The most common score is the FICO score, which ranges from:

• 300 (very risky)

• 850 (very safe)

The higher your score, the more trustworthy you appear.

Why It Matters

Your credit score affects:

• Whether you get approved for a loan or credit card

• The interest rate you pay

• Your monthly payment

Here’s the part most people underestimate:

A lower score doesn’t always mean “no.”
It often means “yes — but at a much higher cost.”

An Example

Adam and Ryan both take out a $25,000 car loan for 5 years.

But they don’t get the same rate.

Adam

• Credit score of 815 → 4.9%

• Payment: $471/month

• Total paid: $28,260

• Interest paid: $3,260

Ryan

• Credit score of 530 → 13.9%

• Payment: $580/month

• Total paid: $34,800

• Interest paid: $9,800

Same car.

$6,540 more.

What Impacts Your Score?

Your credit score is driven by a few key factors:

1. Payment History (Most Important)

Do you pay your bills on time?

• Late payments hurt — a lot

• Consistent on-time payments help

2. Credit Utilization

How much of your available credit you’re using — across all accounts.

Example:

• Credit limit: $1,000

• Balance: $800 → 80% utilization (bad)

Lower is better.

Keep it under 30%.

3. Length of Credit History

How long you’ve had credit accounts.

• Longer history = better

• This is why starting early (carefully) helps

4. Types of Credit

A mix of:

• Credit cards

• Loans (auto, student, etc.)

You don’t need everything — just some variety over time.

5. New Credit

Opening many accounts quickly can hurt your score.

It signals risk.

The One Rule That Matters Most

Always pay your bills on time.

That single habit does more for your credit score than anything else.

No Credit Use, No Credit History

You might think avoiding credit entirely is the safest move.

But if you never borrow, you don’t build a credit history.

And without a history, lenders don’t have much to go on.

Using a credit card — and paying it off in full each month — is a simple way to build a credit history without paying interest.

One More Thing

Your credit score is not a measure of wealth.

It’s a measure of your behavior with borrowed money.

Someone can have:

• A high income and a bad score

• A modest income and a great score

Bottom Line

It’s just a number.
But it determines what you pay.

Now let’s look at what happens if you don’t pay your balance in full.

Card issuers use different formulas, but the minimum payment is typically something like:

The greater of $25, or 1% of your balance + interest + fees

That sounds technical, but here’s what it means in practice:

Your minimum payment will be small — and a large portion of it goes toward interest, not reducing what you owe.

Your interest rate depends on your credit history, which we’ll cover in a future article.

If you’re just starting out as a young adult, lenders see you as more risky and charge higher rates — often in the 26-30% range. Even people with excellent credit typically pay around 18–20%.

For this example, we’ll assume an interest rate of 27.99%.

The Payment Math

Assume:

• Beginning balance: $1,000

• APR: 27.99%

• No additional purchases or fees

• Payments are made on time

The monthly interest rate is:

27.99% ÷ 12 = 2.3325%

Month 1

Beginning balance: $1,000

Interest: $1,000 × 2.3325% = $23.33

1% of balance: $1,000 × 1% = $10

Minimum payment: $23.33 + $10 = $33.33

Ending balance: $1,000 + $23.33 − $33.33 = $990

Month 2

Beginning balance: $990

Interest: $990 × 2.3325% = $23.09

1% of balance: $990 × 1% = $9.90

Minimum payment: $23.09 + $9.90 = $32.99

Ending balance: $990 + $23.09 − $32.99 = $980.10

Key Observation

Notice how little the balance decreases.

In the first two months, you paid $66.32, but your balance only went down by $19.90. Most of your payments go toward interest — especially early on.

Total Cost

If you continue making only the minimum payment:

• It takes 80 months (6 years and 8 months) to pay off

• You pay $1,137 in interest

• That $1,000 balance turns into $2,137 total — more than double the original amount

It Gets Much Worse with Larger Balances

And the larger your balance, the worse this gets.

At $1,000, it takes 6 years and 8 months to pay off with minimum payments.

At $5,000, it takes over 20 years — and the total cost rises to $15,468, more than triple the original amount.

The Takeaway

Minimum payments are meant to keep you paying — not to get you out of debt.

They make the payment feel manageable, but they stretch repayment over years and dramatically increase the total cost.

Avoid this by following one simple rule:

Always pay your full statement balance every month.

If you can’t, pay as much as possible — and avoid adding new charges until the balance is paid off.

They offer convenience, fraud protection, and even rewards like cash back.

But used incorrectly, they can lead to overspending, debt, and expensive interest.

What is a Credit Card

A credit card gives you access to a line of credit — a set amount you’re allowed to borrow.

Each time you swipe, you’re borrowing money. If you don’t pay it back quickly, it becomes a loan.

Each month, your card has a billing cycle. At the end, you receive a statement with everything you charged and the total amount you owe.

Getting a credit card isn’t difficult. Once you’re 18, you can usually get one with a low credit limit — the maximum amount you can borrow.

The Cost of Borrowing

If you don’t pay your statement balance in full, the credit card company charges interest.

This is expressed as an APR (Annual Percentage Rate). Even with good credit, many cards charge around 20%–25%.

That means borrowing $500 and carrying the balance can quickly cost you real money — not because you spent more, but because you didn’t pay it back right away.

The Trap

Credit cards don’t require you to pay the full amount each month. Instead, they offer a minimum payment — often just a small fraction of what you owe.

This sounds helpful, but it isn’t.

If you carried a $500 balance at 24.99% interest and only made minimum payments, it could take years to pay off — and you could end up paying hundreds in interest.

That’s the trap.

The smaller the payment, the more interest the credit card company earns — and the longer you stay in debt.

Minimum payments are designed to keep you in debt longer.

The One Rule

There’s a simple way to avoid all of this:

Always pay your full statement balance every month.

If you do:

• You pay zero interest

• You avoid accumulating debt

• You build a positive credit history over time

That’s it. One rule.

A Simple Guardrail

Treat your credit card like a debit card.

Only spend money you already have.
If you wouldn’t pay cash for it, don’t swipe.

Used correctly, a credit card costs you nothing.

Used incorrectly, it can quietly cost you thousands.

“Only $50 per month.”

That sounded reasonable — until we did the math.

$50 × 24 months = $1,200

The $1,000 mattress now cost $1,200.

That extra $200 is the cost of borrowing money.

Monthly payments can make things feel more affordable than they really are — and often entice people to borrow more than they should.

What a Loan Really Is

A loan is simple:

You get money today.

You pay it back over time.

But you also pay interest — the price of using someone else’s money.

The Three Parts of Any Loan

Every loan has three basic pieces:

Principal
The amount you borrow

Interest Rate
The cost of borrowing

Loan Term
How long you take to repay it

A Simple Example

Suppose you borrow $1,000 at 6% and repay it over 12 months.

Your monthly payment is about $86.

Month 1

• Interest: $1,000 × 0.5% = $5.00

• Principal: $86 − $5 = $81

• New balance: $1,000 − $81 = $919

Month 2

• Interest: $919 × 0.5% ≈ $4.60

• Principal: $86 − $4.60 ≈ $81.40

• New balance: $919 − $81.40 = $837.60

…

Month 12

• Interest: $85.60 × 0.5% ≈ $0.40

• Principal: $86 − $0.40 ≈ $85.60

• New balance: $85.60 − $85.60 = $0

What You Should Notice

• You start paying principal immediately

• Interest is highest at the beginning because the balance is highest

• Each month:

  • interest goes down

  • principal paid goes up

Nothing changes later in the loan — the math just shifts as the balance gets smaller.

Longer Loans Don’t Scale the Way You Might Expect

Extending the loan lowers your monthly payment — but it also means you repay the principal more slowly, so you pay interest for longer.

Same math as before — just stretched over more time.

Suppose you borrow $300,000 at 6% to purchase a home:

• 15 years → ~$2,530/month

• 30 years → ~$1,800/month

• 50 years → ~$1,580/month

Going from 15 → 30 years cuts the payment a lot.

But going from 30 → 50 years barely moves it.

The Tradeoff

Extending the loan keeps lowering the payment — but by less and less as the term gets longer.

Meanwhile, total interest keeps rising:

• 15-year loan → ~$155k interest

• 30-year loan → ~$348k interest

• 50-year loan → ~$648k interest

Same house. Same rate. Just more time.

Extending a loan dramatically increases total cost — but only modestly reduces the monthly payment after a certain point.

Final Thought

Borrowing responsibly starts with understanding how loans actually work.

Loans don’t make things cheaper — they just make the price easier to ignore.

You’ve probably heard the term inflation, which means an increase in the prices you pay for things. As costs like labor, rent, and supplies rise over time, businesses raise prices so the people running them can continue to make a living.

Let’s say Tony owns a local pizzeria and makes just enough from it to pay his personal bills. If the cost of cheese and sauce rises, his rent goes up, and his employees earn higher wages, Tony has to raise his prices too — not to get richer, but simply to keep making a living.

That’s how you might end up paying $21 for a pizza this year even though the same pizza cost $20 last year.

Economists use the term purchasing power to describe how much your money can buy. When prices rise, that purchasing power falls.

Even if the number in your bank account stays the same, inflation quietly reduces what that money can buy. That’s why it can feel like a tax — one you pay every year without ever receiving a bill.

Every good or service has its own inflation rate. Some prices rise quickly, while others change very little. Because people spend money differently, each of us effectively experiences our own personal inflation rate.

The government publishes a single official inflation number based on what it believes represents a typical household. But in reality, inflation affects everyone a little differently.

Inflation is why simply putting money under a mattress — or its modern equivalent, a checking or savings account — isn’t enough. To preserve purchasing power, your savings and investments must grow at least as quickly as your personal inflation rate.

Let’s say your personal inflation rate is 2.5% per year.

If your salary rises by 2.5%, then your income is roughly keeping pace with inflation — before taxes.

If you earn 0% in a checking account (ignoring any fees), then next year your money will buy 2.5% less than it does today.

If you earn 2.5% in an online savings account, then your money will buy about the same amount next year.

If your investments earn 9%, then your purchasing power increases by about 6.5%.

In other words, whether your money grows or shrinks depends on how it grows relative to inflation.

No calculator required.

72 ÷ your annual return ≈ years to double your money

That’s the Rule of 72.

An Example

Let’s say you have $10,000 invested.

If you expect a 9% annual return, the Rule of 72 says your money will double in approximately:

72 ÷ 9 = 8 years

So:

• After 8 years → $20,000

• After 16 years → $40,000

• After 24 years → $80,000

How Accurate Is the Estimate?

Without going too deep into the math, the actual compound growth formula is:

FV = PV × (1 + r)ⁿ

Where:

• PV = present value (starting amount)

• FV = future value (ending amount)

• r = annual return (written as a decimal)

• n = number of years

If you want your money to double, then:

FV ÷ PV = 2

Which means:

(1 + r)ⁿ = 2

The Rule of 72 says that at a 9% return:

72 ÷ 9 = 8 years

Plugging that into the actual formula:

(1 + 0.09)⁸ = 1.993

That’s very close to 2. In this case, the Rule of 72 underestimates the exact doubling time — but it’s impressively accurate for a formula you can do in your head.

And given that real-world investment returns are never perfectly steady anyway, it’s more than accurate enough for planning purposes.

Additional Examples

The chart above shows several returns and compares the estimated doubling time to the actual value.

As you can see, the gap widens as returns get very low or very high — but for common long-term investment return values, the Rule of 72 holds up remarkably well.

It feels like a bonus.

It isn’t.

It’s simply your own money being returned.

Let’s walk through how this actually works.

What is Tax Liability?

Before we talk about refunds or payments due, we need to define tax liability.

Tax liability is the total federal income tax you actually owe for the year.

Let’s use an example.

Susan is single. She earns $70,000 per year from her job. She has total deductions of $21,100 and one child, which qualifies her for the $2,000 Child Tax Credit.

First, we calculate her taxable income:

$70,000 − $21,100 = $48,900

Next, we apply the 2026 tax brackets:

10% × $12,400 = $1,240
12% × ($48,900 − $12,400) = $4,380

Total tax before credits = $5,620

Now we apply the Child Tax Credit:

$5,620 − $2,000 = $3,620

That $3,620 is Susan’s tax liability.

It is her actual federal income tax bill for the year.

Now let’s look at how that bill gets paid.

Tax Withholding

Susan doesn’t wait until April to write a $3,620 check to the IRS.

Instead, her employer withholds money from each paycheck throughout the year and sends it directly to the government.

This is called tax withholding.

Think of it as making installment payments toward her annual tax bill.

If Susan is paid twice per month, she receives 24 paychecks per year.

If her total tax liability is $3,620, that averages out to about:

$3,620 ÷ 24 = $150.83 per paycheck

If exactly $150.83 were withheld each time, she would finish the year having prepaid exactly $3,620.

No refund and no balance due.

But withholding isn’t perfect.

It’s based on estimates from the W-4 form she fills out when she starts her job (or whenever she updates it).

But here’s the important part:

Her tax liability doesn’t change based on how much was withheld.

How Your Refund (or Payment) is Determined

When you file your tax return, your refund or payment is determined by comparing two numbers:

1. Your tax liability

2. The total amount that was withheld and sent to the IRS

Your refund or payment is simply the difference between those two numbers.

Let’s go back to Susan.

Scenario 1: Refund

If $175 was withheld from each of her 24 paychecks:

$175 × 24 = $4,200 total withheld

But she only owes $3,620.

She overpaid:

$4,200 − $3,620 = $580

So she receives a $580 refund.

Scenario 2: Payment Due

If $125 was withheld from each of her 24 paychecks:

$125 × 24 = $3,000 total withheld

But she owes $3,620.

She underpaid:

$3,620 − $3,000 = $620

So she must send the IRS $620 when she files her return.

The Bottom Line

If Amazon overcharged you all year and sent you a check the following spring, you wouldn’t celebrate.

That’s what a tax refund represents.

It doesn’t mean you won.

It means you overpaid.

Last time, we covered the different types of income and how the IRS taxes each one.

Today, we’re clearing up a common point of confusion: tax deductions and tax credits.

Tax Deductions

A tax deduction reduces your taxable income — not your tax bill.

Let’s say you earn $70,000 from your job.

This is your gross income.

But the IRS does not calculate your tax using that full amount.

First, your income is reduced by certain deductions, such as:

• Pre-tax health insurance premiums

• FSA or HSA contributions (accounts used to pay for healthcare expenses)

• Traditional 401(k) or IRA contributions

• Student loan interest

• The standard deduction

After subtracting those amounts, what remains is called your taxable income.

That’s the number the IRS uses to determine how much tax you actually owe.

Let’s say you earned $70,000 in 2025, contributed $5,000 to a Traditional IRA, and you’re single with one child and taking the standard deduction ($16,100 for single filers for 2026).

Gross income: $70,000

Total Deductions: $5,000 + $16,100 = $21,100

Taxable Income: $70,000 - $21,100 = $48,900

Even though you earned $70,000, you’re only taxed on $48,900.

That means $21,100 of your income is shielded from tax through deductions.

Takeaway: Deductions reduce the amount of income that gets taxed.

Tax Credits

A tax credit reduces your tax bill directly.

Not your income.

Not your taxable income.

Your actual tax owed.

Using the example above, the child in the household qualifies for the Child Tax Credit, which is worth $2,000.

Using the 2026 tax brackets from our previous post, we can calculate the federal income tax owed on $48,900 of taxable income:

10% x $12,400 = $1,240

12% x $36,500 = $4,380

Total federal income tax (before applying credits): $1,240 + $4,380 = $5,620

Now we apply the credit:

Child Tax Credit: - $2,000

Final tax owed: $3,620

Takeaway: Credits reduce your tax bill dollar for dollar.

In our example, a $2,000 tax credit saves the taxpayer $2,000.

But a $2,000 tax deduction would only save them $2,000 x 12% = $240

One final observation.

The final tax bill of $3,620 is just 5.17% of $70,000.

Many people overestimate how much they pay in federal income taxes.

They focus on their top tax bracket (in this case 12%) — not their effective tax rate.

But in most cases, they are very different numbers.

Taxes Are (Usually) Your Biggest Expense

For most households, taxes are the single largest expense each year.

Reducing your tax bill starts with understanding the system — and the first rule is simple: not all income is taxed the same.

Let’s briefly walk through the most common income types most households encounter, and how the IRS treats each one.

Wages

Income earned from an employer in exchange for your time and labor.
This is the most familiar — and often the most heavily taxed — form of income.

In addition to federal income tax, wages are subject to payroll taxes: Social Security and Medicare.

In 2026, Social Security tax is withheld at 6.2% on wages up to $184,500. Wages above that amount are not subject to Social Security tax.

In 2026, Medicare tax is withheld at 1.45% on all wages, with no income cap. An additional 0.9% Medicare surtax applies to wages above $200,000 for single filers and $250,000 for married couples filing jointly.

Interest

Income earned from lending money, such as through savings accounts, CDs, and bonds.

Interest is generally taxed like wages.

Short-Term Capital Gains

Profits from selling an investment held for 365 days or less.
The IRS taxes these the same way it taxes wages and interest.

Long-Term Capital Gains

Profit from selling an asset held for more than 365 days, such as stock in publicly-traded companies.
These gains receive more favorable tax treatment than wages or short-term gains.

An additional 3.8% Net Investment Income Tax (NIIT) applies to investment income for single filers with income above $200,000 and married couples filing jointly with income above $250,000.

Qualified Dividends

Some companies pay dividends to their shareholders, which are cash payments made per share, often quarterly. Dividends that meet specific IRS requirements — including a minimum holding period — qualify for the same tax treatment as long-term capital gains.

Collectibles

Assets like art, gold, silver, and certain coins fall into a special tax category. Even when held long term, they’re taxed differently — and often less favorably — than stocks. Long-term gains on collectibles are taxed at rates up to 28% and may also be subject to the Net Investment Income Tax (NIIT).

Cryptocurrency

Crypto is treated as property, not currency.
Buying, selling, or trading can trigger capital gains or losses.

Income We’re Skipping (For Now)

Real estate ownership and operating a business both come with significant tax advantages — and major complexity.
They deserve their own posts, so we’ll leave them out for now.

Key Takeaway

The U.S. tax code taxes labor income more heavily and long-term investment income more favorably in order to encourage investment.

Two investors put money into an index fund that returns 9% annually.

Investor A starts at 18 and invests $1,000 per year for 8 years and then stops.

Investor B starts at 26 and invests $1,000 per year for 40 years.

Who do you think ends up with more at age 66?

Investor A winds up with about $9,300 more, despite investing just $8,000 in total — compared with Investor B, who invested $40,000.

A high income from a career can certainly buy a lot of nice things: a beautiful home, nice cars, and exotic vacations. But financial wealth determines whether — and for how long — a lifestyle continues once you stop working. Being wealthy means your lifestyle isn’t dependent on your labor.

Financial wealth is most commonly measured using something called net worth. It’s calculated by adding up everything you own — cash, investments, and assets like a home or vehicles — and subtracting everything you owe, including mortgages, car loans, and credit card and student loan debt.

Defining wealth this way highlights an important point: income only turns into wealth if spending stays below it. As income rises, spending often rises right alongside it — larger homes, nicer cars, more expensive vacations. When that happens, there’s little left to save or invest, and net worth struggles to grow despite a high salary.

Most moderately wealthy people don’t get there through sudden windfalls. They build wealth slowly and predictably by keeping their expenses below their income and consistently investing the difference over many years. That gap between income and spending is what ultimately becomes net worth; the larger the gap, the faster it grows.

You can earn a lot and have little net worth — or earn modestly and build significant wealth. Income sets the ceiling, but spending and saving determine the outcome.

A custodial Roth IRA is simply a Roth IRA owned by a minor, with a parent or guardian managing it until the age of majority, which varies by state.

Choose a Brokerage

Several reputable financial companies offer custodial Roth IRAs. While many readers are familiar with Vanguard, it currently only offers custodial Traditional IRAs.

Both Fidelity and Charles Schwab offer custodial Roth IRAs with excellent investment options. You can’t go wrong with either.

What You’ll Need

Critcal: The teen must have earned income to qualify for a Roth IRA.

Account holder (teen)

• Social Security number

• Government-issued ID (passport or driver’s permit/license)

• Employment details

  • Occupation

  • Employer name and address

  • Annual income (estimate is fine)

Custodian (parent or guardian)

• Social Security number

• Government-issued ID

• Occupation and employer name/address

Bank account to link

• Bank name

• Routing and account numbers

• Can be in the teen’s or custodian’s name

Open the Account

Go to the brokerage’s website, click Open an Account, choose Custodial Roth IRA, and complete the application. Phone support is available if you have questions.

If you’re using Fidelity, here’s a direct link to their custodial Roth IRA page:

Fidelity Custodial Roth IRA

Fund the Account

Once the account is open, link a bank account and make an initial contribution.

Contributions are limited by the teen’s earned income for the year (up to the annual Roth IRA limit), and there are no minimums at Fidelity or Schwab.

Choose an Investment

Unlike a checking or savings account, funding an investment account isn’t enough — you must choose an investment.

A low-cost U.S. stock market index fund is a common recommendation. In particular, total market index funds aim to own nearly every publicly traded U.S. company.

At Fidelity, a great choice is FZROX (Fidelity ZERO Total Market Index Fund), which has a 0.00% expense ratio.

An expense ratio is the annual fee charged by the fund, expressed as a percentage of your investment. Low-cost index funds typically have expense ratios well under 0.1%.

Make sure “reinvest dividends” is selected so dividends are used to buy additional shares in the fund.

One important note: avoid buying mutual funds from other brokerage companies inside your account. These often come with transaction fees that can be a large percentage of small or recurring investments.

Set Up Automatic Contributions

Once the account is funded and invested, you can put it on autopilot with recurring contributions. Fidelity and Charles Schwab support scheduled transfers and specific fund purchases.

Most people save and invest more when it doesn’t require repeated action.

Opening a custodial Roth IRA isn’t complicated — and getting started matters far more than fine-tuning the details.

That’s why accounts like 401(k)s and IRAs matter so much. They aren’t just investment vehicles — they’re tax shields.

For working teens and college students, the Roth IRA unlocks a rare and powerful tax advantage. Here are the key points to know:

• If you have earned income from a job, you can open a Roth IRA.

  Interest from savings accounts or cash gifts don’t count — it must be job income.

• Most working teens are in the 0% federal income tax bracket.

  Even if federal taxes are withheld from your paycheck, they’re typically refunded in full when you file your tax return.

• Roth IRA contributions are taxed once — during the year in which you earn the money.

  After that, the money grows tax-free and can be withdrawn tax-free in retirement.

• For teens and college students, that usually means the money is never taxed at all.

  Not when it’s earned.

  Not while it’s growing.

  Not when it’s withdrawn later in life.

• Small contributions early can matter more than large ones later.

  Opening a Roth IRA in your mid-teens and contributing even $100 per month through your early 20s can fund a meaningful portion of retirement — before you ever earn a full-time salary.

A quick note for parents: Roth IRAs aren’t counted as student assets on the FAFSA, so having one doesn’t change financial aid eligibility.

An Example

Julia starts working part-time at a grocery store at 16, earning about $6,000 per year. She invests $300 per month into a Roth IRA for two years, contributing a total of $7,200.

In college, she works more — a campus job during the year and waitressing in the summers — earning about $12,000 per year. She continues contributing to her Roth IRA, this time at $500 per month for four years, adding an additional $24,000.

By age 22, Julia has contributed $31,200 to her Roth IRA. Now let’s see how it grows with no additional contributions.

The Takeaway

When a teen earns income in the 0% tax bracket, a Roth IRA allows them to avoid taxes on that money — and its growth — for life. Even modest contributions made early can grow into something meaningful without requiring perfect timing, large deposits, or financial expertise.

If your teen has a job, opening a Roth IRA is one of the simplest ways to give them a financial head start. Time will do the rest.

If you want the details we didn’t cover here, I’ve laid them out in a separate post:

Roth IRA and the 0% Tax Bracket

In the next post, we’ll discuss how to open and fund a Roth IRA.

If you only want the headline takeaway, it’s this:

When earned income is taxed at 0%, a Roth IRA turns that money into tax-free money for life.

Here’s how that works under current U.S. tax law.

Earned income vs. Investment income

The IRS treats income from working very differently than income from investments.

Earned income includes:

• W-2 wages from hourly or salaried jobs (retail, food service, lifeguarding, internships, etc.)

• Self-employment income (babysitting, tutoring, lawn care — if reported)

This is the income that determines whether you can contribute to a Roth IRA.

Investment income includes:

• Interest

• Dividends

• Capital gains

This is also referred to as unearned income.

Why most working teens pay 0% federal income tax

Even if parents claim a teen as a dependent, the teen still files their own tax return.

Because teens usually earn relatively little, their income is often fully covered by the standard deduction. In practical terms, that means:

• Most teens owe no federal income tax on their wages

• If taxes are withheld from paychecks, they’re often refunded when taxes are filed

For 2026, the federal standard deduction for a single filer is $16,100. For dependents, the deduction is tied to earned income, but the outcome is usually the same: teens with typical part-time jobs owe $0 in federal income tax.

(Separate payroll taxes like Social Security and Medicare still apply. This discussion is about federal income tax, which is what matters for Roth IRAs.)

The “kiddie tax”

You may have heard that kids get taxed at their parents’ rate once income gets high enough. That’s partially true — but it applies to investment income, not wages.

Important points:

• The kiddie tax does not apply to job income

• It does not affect Roth IRA eligibility

• It does not change how wages are taxed

A teen can earn wages, owe 0% federal income tax on those wages, and contribute that money to a Roth IRA — even if they also have investment income elsewhere.

How Roth IRAs are taxed

Roth IRAs follow three simple rules:

1. You contribute money that has already been taxed

2. The money grows tax-free

3. You can withdraw it tax-free in retirement

For most adults, this means paying taxes now to avoid taxes later.

For working teens in the 0% bracket, it usually means:

• No tax when the money is earned

• No tax while it grows

• No tax when it’s eventually used

That combination is rare — and temporary.

Limits

A few basic rules still apply:

• There’s a yearly limit on how much you can contribute

  The 2026 IRA contribution limit is $7,500 for anyone under 50

• You can’t contribute more than you earn

  “Earnings” here means your gross wages — the amount you’re paid before any taxes or other deductions.

• Very high incomes can limit Roth eligibility

  In 2026, the ability to contribute to a Roth IRA begins phasing out at a Modified Adjusted Gross Income of $153,000 for single filers. For teens and college students with typical jobs, these limits almost never come into play.

Bottom line

For working teens and college students, Roth IRA rules are unusually simple. Earned income determines eligibility, wages often fall into the 0% federal tax bracket, and Roth contributions — along with their growth and qualified withdrawals — are never subject to federal income tax.

Once funds no longer need to be immediately available — and can tolerate some ups and downs — a different category of accounts comes into play. These are designed for long-term growth.

Employer-Sponsored Retirement Accounts

What they are

• Investment accounts offered through work

• Often named after the section of the tax code that governs them:

  • For-profit companies: 401(k)

  • Schools, hospitals, and non-profits: 403(b)

  • State and local governments: 457(b) or 401(a)

  • Federal government and military: Thrift Savings Plan (TSP)

Benefits

• Favorable tax treatment

• Often include an employer match

  • The employer adds money alongside what you contribute

  • A $1-for-$1 match effectively doubles the amount invested

  • Because it’s so valuable, try to capture your employer’s full match

• Automatic payroll deductions make saving regular and low-friction

Limitations

• Limited investment choices

• Restrictions on when money can be accessed; intended to be accessed at or near retirement age

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Individual Retirement Accounts (IRAs)

What they are

• Investment accounts you open on your own

• Widely available at many large investment firms such as Vanguard, Fidelity, and Charles Schwab

• Two main types:

  • Traditional IRAs — taxes are paid later, when money is taken out

  • Roth IRAs — taxes are paid up front, before money is invested

Benefits

• Favorable tax treatment

• More control over investment choices: access to a wide range of investments, including mutual funds, index funds, ETFs, stocks and bonds

Limitations

• No employer match

• Lower annual contribution limits than many workplace plans

• Restrictions on when money can be accessed

• Contribution eligibility can phase out at higher income levels

Taxable Brokerage Accounts

What they are

• Standard investment accounts with no special tax advantages when money is deposited or withdrawn

Benefits

• Maximum flexibility

• No limits on how much you can invest

• No restrictions on access to money

• Very broad investment choices

Limitations

• No tax deferral or sheltering

• Investment income (ie. interest, dividends, and capital gains) is generally taxed each year

We’ll cover the tax treatment of dividends and long-term capital gains in a future post. While these accounts don’t receive the same tax advantages as retirement accounts, the tax rules are often more favorable than many people expect.

Over this series, we’ve looked at the main places money typically goes: checking for spending, savings for near-term needs, and investing for long-term growth.

The key isn’t choosing one account type over another, but understanding the role each one plays — and using the right tool for the right job.

In some cases, the tax treatment of these accounts creates outsized advantages — particularly for young earners. We’ll explore one of the most powerful examples next.

Earning interest over time makes a meaningful difference. Once your checking account comfortably covers expenses and avoids fees, the next question is where to keep money you don’t plan to spend right away.

Savings Accounts

Benefits

• Easy to link to your checking account

• Often provide immediate access if savings and checking are at the same bank

• Simple to manage, sometimes through a single login with the bank

• Balances are protected by government-backed insurance (Federal Deposit Insurance Corporation - FDIC) up to applicable limits

• Provide a separate bucket from day-to-day spending

Limitations

• Interest rates are typically very close to zero, especially at large traditional banks

• Balances grow very slowly and often lose purchasing power over time due to inflation

High-Yield Savings Accounts (HYSAs)

Benefits

• Pay meaningfully higher interest than traditional savings accounts

• Higher interest improves the chances of preserving purchasing power over time

• Typically allow easy transfers to and from a linked checking account

• Well suited for emergency funds and money you may need over the next few months or years

• Balances are often protected by FDIC insurance up to applicable limits

Limitations

• Usually offered by online banks rather than physical branch locations

• Transfers may take a day or two, limiting same-day access

• Interest rates can change over time

• Typically no in-person customer support

Certificates of Deposit (CDs)

Benefits

• Offer a fixed interest rate for a defined period of time

• Provide certainty: you know the rate and term upfront

• Often pay more interest than traditional savings accounts, and sometimes more than HYSAs

• Balances are protected by FDIC insurance up to applicable limits

Limitations

• Money is locked up for the duration of the term

• Early withdrawals usually result in lost interest

• Funds often need to be rolled into a new CD when the term ends, or interest stops accruing

• Not suited for money you may need on short notice

These accounts trade off access, flexibility, and interest in different ways. The right choice depends less on the rate and more on when you’ll need the money.

Next, we’ll look at accounts designed for longer-term growth.

But investing is only part of the picture. Your paycheck has to be deposited somewhere, and different accounts are designed for different purposes.

That makes it worth understanding the main types of accounts, what each one is used for, and the tradeoffs involved.

Checking accounts

For most people, a checking account is the first one they actively use — where paychecks arrive through direct deposit and routine expenses and payments are handled. It acts as the central pass-through for your money: income comes in, bills get paid, and funds move to and from your other accounts.

Checking accounts are designed for access and convenience — not for growing your money. They typically pay little or no interest and may charge fees that act like a negative interest rate on your balance.

Fees are more impactful than they appear at first glance. A $10 monthly fee doesn’t sound like much, but on an average balance of $2,000, it works out to roughly a 6% annual cost. That’s not just missing out on interest — it’s paying the bank to hold your money.

Many banks waive these fees if you meet certain conditions, often by using direct deposit or maintaining a minimum balance. The details vary by bank, so it’s worth understanding the rules before opening an account.

Once day-to-day spending is covered, the next question is where to keep money you don’t plan to spend right away — which we’ll look at next.

But here’s what isn’t discussed nearly enough: the youngest years of earning are the most valuable financial years. A simple habit of investing, when started early, can outweigh decades of greater effort later on.

Many people reach midlife wishing they had started earlier. By investing from a young age - even in small amounts - you can dramatically improve the odds of having enough in your sixties, or even earlier. When investing is done consistently over long periods of time, the benefit of time really adds up.

This is the power of compound interest. It’s often called the eighth wonder of the world, and a few charts will illustrate why.

We’ll cover specific investment options in future posts. For now, let’s keep things simple and assume an investment that earns a 9% annual return.

If you’re not familiar with the term return, think of a savings account that pays 9% interest per year. Deposit $1,000 on January 1st, and by the next New Year, that $1,000 has grown to $1,090.

The chart below compares two investors. The first invests $1,000/year for eight years starting at age 18, then stops and lets the money grow until age 66. The second waits until age 26 and invests $1,000/year every year until age 66.

Despite contributing just $8,000 in total - compared with $40,000 for the later investor - the early investor ends up with more.

The bar chart below shows the monthly amount required to reach $1 million by age 65, assuming a 9% return.

(To save $2 million, simply double the amounts shown.)

Starting earlier means you need to save less each month. That part is intuitive - but it doesn’t fully explain why the difference is so dramatic.

The chart below breaks the $1 million into two parts: what you contribute from your own income (labeled “savings”) and what comes from investment growth (labeled “interest earned”).

Starting at age 18, you would invest for 47 years and contribute about $63,500 in total (47 years x 12 months x ~$113). The remaining $936,500 - nearly all of the $1 million - comes from compound growth.

Starting later flips that balance, requiring far more of the total to come from your own contributions.

Starting earlier doesn’t just reduce how much you need to save each month - it dramatically reduces how much of your own money you need to contribute over a lifetime. Time does the heavy lifting.

That’s the advantage of compounding, and it fades with age.