Learn how to open a Roth IRA for kids – help your children, give them a head start on the future! Keep reading for more on opening a Roth IRA for minors.
As with any financial situation, we recommend carefully consulting with your trusted financial advisor to ensure this is a good fit for you and your family.
Roth IRA for Kids – Enhancing your Children’s Future
Table of Contents
- 1 Roth IRA for Kids – Enhancing your Children’s Future
- 1.1 Should Parents open a Roth IRA for Kids?
- 1.2 Rules – Roth IRA for Kids
- 1.3 Getting Started: How to Open a Roth IRA for your kids
- 2 THANK YOU FOR STOPPING BY!
Take this opportunity to brighten your child’s future! If the conditions are right, this could be an incredibly powerful tool for your kid’s future. Additionally, it can help teach them the importance of saving and the value of managing their finances. In my opinion, the real boost comes from starting amazing habits while they are young! Let’s unpack some details to support your research.
Should Parents open a Roth IRA for Kids?
Is your child working hard and saving their earned income? Take advantage of the opportunity, offer some parenting that helps them prepare for their future, and build financial discipline with their income. No time like the present for a practical lesson!
What is a Roth IRA for Kids?
Specifically for those under the age of 18 (minors), a Roth IRA for kids is there for the taking! It allows participants to save for the future in the same type of vehicle that adults use. In particular, it is a retirement vehicle. Used correctly, participants can later withdraw their earnings, tax-free, at the age of 59 1/2. Additionally, by starting young, contributions can be withdrawn (not capital gains) in the future to pay for things like a car, or other “big first purchases.”
A legal custodian is needed to set up the Roth IRA. This person can be a parent, and they will have control of the Roth IRA until the minor child is 18 or 21 (check local rules, 21 in most states).
In this example, the parent will be able to fully manage the account which includes investment selection and the like. The child is the beneficiary and will take control at the age requirement designated in your state (generally 18 or 21). At that age, the assets and control of the Roth IRA are fully available to your child.
Teaching your Children about Finances in Real-time!
While the benefits of strong future financial value are nice, I believe the stronger lesson here is the opportunity to teach your children. Parents, this is a big one! Over the years, your child can watch the money accumulate and grow. They also begin to see how a budget works (albeit a simple one at first) and can appreciate the value of their hard work earning income.
While it is never “too late” for a teaching opportunity, the earlier you start, the more time you’ll have to reinforce the positive behavior. Lead by example! This is a great time to tune up your own budget and finances and share in the experience with your child as well. My friend, I’m so excited for you! Give them a leg-up!
Roth IRA or Traditional IRA for Kids?
Personally, I believe a Roth IRA works well for children. As a general rule, Roth IRAs benefit those who will be in a higher income bracket later in life (I am a huge fan of the tax treatment of the Roth IRA as well). A traditional IRA will help to lower current year taxable income (remember that Roth IRA contributions are made from after-tax earnings). However, for most minors, today’s benefit is relatively small by comparison. Especially for minors, the benefits package of the Roth IRA is fantastic and gets better with time. More on contributions, below!
Rules – Roth IRA for Kids
Right off the bat, I’d like to strongly suggest you partner with your trusted financial advisor and CPA to ensure your family’s situation is properly set up and documented. Here are some summary points to keep in mind as you prepare!
Importantly, the IRS has published guidelines on what gross income includes and how to report it. For earned income, I strongly recommend keeping careful and detailed records. If you can, try to collect a W2 as well. If one isn’t available (e.g. if your kids mow lawns for the neighbors), keep track of the dates, amounts, and from whom the money was received.
Budgets are important for any household, and this is yet another good example of how they can help. As a custodian, you’ll need to help your child keep track of their earned income for the year as this will dictate how much can be contributed to their Roth IRA.
At the time of this writing, the Roth IRA contribution limit is $6,000 for the calendar year. This means your minor has the potential to contribute up to that amount each year!
Who Can Contribute?
So long as the minor’s earned income for the year is followed as a “max” amount, Fidelity suggests using a parental “match” as a way to incentivize youngsters to contribute. Even with contributions made on the child’s behalf, the key is to ensure the max of $6,000 or their respective earned income is followed (pick the lesser as your target).
Following the logic above, if your child’s earned income is $7,000 from jobs over the year, the maximum for the Roth IRA would be $6,000, but that could be made up of $3,000 of the child’s money and a “matching” bonus of $3,000 from the parents.
Additionally, let’s say your child makes $2,000 in the year. Then, the maximum contribution would be $2,000, instead. However, that could also be made up of $1,000 of the child’s money and $1,000 from the parents. What a powerful tool!
In this custodial account for your minor, their respective Roth IRA contributions are limited to the amount of earned income they have within the year. Good news – this includes self-employment as well. If your minor child mows lawns, teaches music lessons, provides tutoring services, babysits, etc., then document and keep track: this is fantastic for their Roth IRA!
As with everything, make sure you check with a trusted financial advisor, and I recommend taking time to ensure you are following the rules. I’m a “color within the lines” kind of guy, and examples of a “gray area” would be if you paid your child to pick up their room, or wash dishes. In general, standard house chores don’t count as earned income.
If you personally fall outside of the Roth IRA income limits, your child can still benefit, so don’t worry! For example, in 2021, according to the IRS if your MAGI (Modified Adjusted Gross Income) is greater than or equal to $208,000 that means you cannot personally contribute to your Roth IRA.
Rules for withdrawals are what you’d expect – they promote leaving the money untouched until the retirement age of 59 1/2, which is the point of such a vehicle.
When can kids access the money?
At the age of 18 or 21 (check with your state’s rules), your child assumes control of the Roth IRA. Some may be concerned that the hard work and years of prior saving would go to waste. While anything is possible, I encourage parents to see this as an opportunity to teach their child at a young age, reinforce the important values of budgeting and saving, all backed up by giving them control when the time comes.
Set back and enjoy the financial benefit you’ve provided to your child AND watch the good habits and discipline, honed over the years, propel them into the next stages of life.
What about withdrawing Contributions?
Yes, they generally can withdraw the contributions made up until this point. Remember, any disbursements from Roth IRAs are first made from the contributions. This benefit could play out by providing an opportunity to buy their first car using the contributions made over the years.
However, I highly recommend you check with your trusted Accountant to verify your situation and requirements align properly to avoid any fees or penalties. When used properly, Roth IRAs are quite flexible!
Managed properly, imagine what your child’s Roth IRA will look like one the years – especially given the tax-free growth! Additionally, when withdrawn at retirement, those disbursements will be tax-free as well (provided the rules are followed, etc.). This works because the rules are that Roth IRA contributions are made with after-tax dollars.
Getting Started: How to Open a Roth IRA for your kids
Ready to get started? Here are a few places you can look to see what works best for you and your hard-working child! My friend, I wish you and your family the very best of luck on your financial journey. The effort you are making today will make a difference in your child’s life.
I always recommend shopping your options around; here are few options to start. Check out Fidelity, or Charles Schwab to get started. I am not sponsored by any company mentioned in this post. However, I have tried Fidelity for other purposes and found them to be effective and responsive to my questions. I have also heard good things about Charles Schwab as well!
Investment Account Fees
This is a matter of preference and the value you get for your money; make sure to understand the fee structure. Fees are part of the equation, but as Kiplinger aptly notes, these account fees can “can erode returns over time.”
Once you get an account opened up, the Roth IRA can house various types of assets including stocks, bonds, ETFs, and Mutual Funds. Not sure what is best? Oftentimes, the brokerage you selected provides questionnaires that will help you decide from their available options. Beyond that, as a general rule of thumb, with the longer-dated timeline, your child has until retirement it might make sense to seek more risk in return for higher yields. Compounding, this additional yield could really add up over the years. However, make sure and consult with your trusted financial advisor about specifics to your particular situation and risk tolerances.
As you move through your available options, remember to keep an eye on expense ratios! All things equal, the smaller the better for you.
THANK YOU FOR STOPPING BY!
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