It’s never too early to start saving for retirement, so brokerages offer Roth individual retirement accounts (IRAs) for kids under 18.
One of these “custodial Roth IRAs” can only be opened if the child has “earned income” to be put into the account. For kids, that can mean getting money from babysitting, mowing lawns, selling lemonade, or getting a job with a pay stub. Cash from savings or allowances doesn’t count. Only the child’s money can be given by the kid or someone else on their account.
Since there is no age limit on Roth IRAs, families can use them to help their kids save for retirement and build wealth early. It gives parents and kids a chance to talk about saving and spending, and the money could also grow tax-free for decades.
Joshua Lieberman, a partner at the insurance and wealth management company Lenox Advisors, says that having a Roth IRA is “a gift of financial literacy and an incentive to work and learn how the world works.”
Why is it good to start a Roth IRA so early?
The growth adds up. A snowball effect is used to make money grow faster over time.
What happens: Your initial deposit gets interest added to your amount at the end of the month. Next month, the money you put in and the interest you got last month will earn interest.
Together, the original purchases and the money made from them grow. Even if you only save a bit, your balance can produce significantly over time. The longer you spend your money, the more likely it is to develop.
By dividing 72 by your rate of return, financial experts can figure out how long it will take for your money to double. For example, if your rate of return is 6%, your money should double every 12 years (72 split by 6).
Max Jaffe, a CPA and chartered retirement planning counselor at TBS Retirement Planning, says that compounding is one of the most potent powers in the world.
To get a Roth IRA, how old do you have to be?
When a kid opens an account at Fidelity, the average age is 13.7 years old, and the average amount is about $2,700. But an adult can start a Roth IRA for a child of any age, even if the child is zero years old.
Kelly Lannan, Fidelity’s senior vice president of new accounts, says that even a 9-month-old baby paid to be in a photo shoot can have an IRA. “Earned income is more important than age.”
What should I do to stay out of trouble with the IRS?
If your child gets a pay stub or W-2 wage breakdown, you can save it for tax reasons just like you would your own.
If your child gets paid cash without a receipt, you should write down each time how much money was given and what the work was.
“We usually suggest an Excel (spreadsheet), but the IRS doesn’t have a single way to do it,” Lannan said, adding that a handwriting log in a notebook or calendar is probably OK, too. “You also wouldn’t need to do this unless you were audited.”
It may be hard to get a child to give up their hard-earned money for a Roth IRA, so an adult can make contributions as a treat for the child working, or the child can put some of their earnings into the Roth IRA, and you can match that amount. Ensure that the total investment is at most what the child earns or more than the Roth IRA limit of $6,500 in 2023.
How do you use a Roth IRA?
Once you know how the youth Roth IRA works, it’s the same as any other Roth IRA.
In 2023, the most that can be put in is $6,500, which must be money already taxed. This means there are no upfront tax breaks, but payments after age 59 and a half are tax and penalty-free if the money has been in the account for at least five years.
If you need money sooner, you can always take out your payments, but not your gains, as long as the account has been open for at least five years. You might not have to pay taxes on your earnings if you use the money to buy your first home, become ill, or die.
Does my child have access to it?
No, the custodian stays in charge of the child’s Roth IRA. This means the custodian makes decisions about payments, investments, and withdrawals. The person in charge also gets statements.
But the kid ultimately owns the account, so the money must be used to help the child. When the minor hits a certain age, usually 18 or 21, the assets must be moved to a new account in their name, and the child gets complete control of the report.
By then, you should have talked to your child about saving and spending for retirement, and you should be able to handle the account wisely.
“We hope these accounts will help parents and kids talk about money,” says Lannan.
FAQs
Can you explain what a custodial Roth IRA is?
A custodial Roth IRA is an investment account for children under 18, which their parents or legal guardians can open for individual retirement. The report is established in the child’s name, and the custodian manages the investments until the child reaches the age of majority.
Who is eligible to open a custodial Roth IRA?
If a child has earned income, their parents or legal guardians can open a custodial Roth IRA on their behalf. The child must also be under the age of 18 at the time the account is established.
What are the benefits of a custodial Roth IRA?
A custodial Roth IRA offers several benefits, including tax-free growth and tax-free withdrawals in retirement. It also allows parents to teach their children about the importance of saving for retirement at an early age.
What are the contribution limits for a custodial Roth IRA?
A custodial Roth IRA’s maximum contribution is equivalent to a traditional IRA’s. The current limit for 2021 is $6,000, but if the child is 50 years of age or older, the maximum contribution increases to $7,000.
Can the child withdraw the funds before retirement?
Yes, the child can withdraw the contributions at any time without penalty. However, if the earnings are withdrawn before age 59 ½, a 10% penalty and income taxes may apply.
Can the custodian make contributions to the account?
Yes, the custodian can make contributions on behalf of the child. Still, the total contributions cannot exceed the child’s earned income or the annual contribution limit.
What happens to the account when the child reaches the age of majority?
When the child reaches the age of majority, the account is transferred to their name, and they become the account owner. They can continue to make contributions and manage the investments on their
