Empowering Young Savers 💰 A Guide to Roth IRAs for Minors

Jeff Bernier |

By: Jamie Stolz, CFP®, MBA

Securing a bright future for our children is every parent's aspiration. Financial planning is a cornerstone in realizing this dream, and yet, one tool often overlooked in this pursuit is the Roth Individual Retirement Account (IRA) for kids. At TandemGrowth Financial Advisors, we are committed to equipping families with the knowledge and strategies necessary for financial independence and success. In this month’s blog, let's delve into how Roth IRAs can serve as a foundational step in your children's financial journey.

Understanding Roth IRAs for Kids

A custodial Roth IRA is a tax-advantaged retirement account established for a child under 18 years old who has earned income. Managed by an adult custodian until the child reaches a certain age (typically between 18 and 25, depending on state regulations), this account offers a unique opportunity for children to begin their journey towards financial security. Potentially qualifying income could come from babysitting, lifeguarding, or dog-walking, as examples. Unlike traditional savings accounts, a Roth IRA for kids provides tax-free growth and withdrawals, making it an ideal platform for introducing children to the concepts of compound interest and tax-advantaged saving.

The Advantages

Tax-Free Growth: Contributions to a Roth IRA grow tax-free, and withdrawals made in retirement remain untaxed. This means the funds your child invests now have the potential to multiply manifold by the time they retire, all without being diminished by taxes.

Financial Education: Initiating a Roth IRA for your child not only secures their financial future but also imparts practical financial education. It instills the value of saving, investing, and planning for the future from a young age.

Flexibility: Roth IRAs offer unparalleled flexibility compared to other retirement accounts. For example, contributions (but not earnings) can be withdrawn at any time without penalty. This makes it a versatile tool for future financial needs, like education expenses or a first home purchase. (After the account has been active for five years, funds can be withdrawn free from federal income tax and penalties once the account owner reaches age 59½. Similar to other custodial accounts, withdrawals must be for the benefit of the child. In cases where funds are needed earlier than 59½, other qualified, tax and penalty-free withdrawals include first-time home purchase (up to $10,000), disability, or in the event of death.)

Eligibility and Contributions

To establish a Roth IRA for your child, they must have verifiable earned income. Each year, contributions can amount to 100% of the child’s income, capped at $6,500 for 2023 and $7,000 for 2024. Contributions can be made by parents, grandparents, or even the children themselves, fostering a collaborative effort within the family towards financial growth.

Getting Started

Open a Custodial Account: Since minors cannot independently open an IRA account, a custodial Roth IRA account must be established. This account will be managed by an adult until the child reaches the age of majority.

Document Income: Ensure you have proper documentation of your child’s earned income, as this will be required to open and contribute to their Roth IRA. Calculating a child's earned income can sometimes be challenging, especially without a W-2 or tax return. IRS publication 590-A, Table 1-1, serves as a valuable resource to understand income requirements for Roth IRAs, or consult your tax advisor for assistance.

Choose Investments Wisely: Roth IRAs offer a wide array of investment options, from stocks and bonds to mutual funds. Select a diversified portfolio aligned with your child’s age, time horizon, risk tolerance, and investment objectives.

Involve Your Child: Engage your child in the process. Discuss the importance of saving, how the Roth IRA operates, and the investments within their account. This involvement is instrumental in fostering financial literacy and independence.

Conclusion

At TandemGrowth Financial Advisors, we recognize the significance of early financial planning. A Roth IRA for kids transcends being merely a retirement savings account; it serves as a tool for financial education, discipline, and growth. By initiating early, your child can reap the benefits of tax-free growth, acquire invaluable financial insights, and lay the groundwork for a secure and prosperous future.

Information provided here is for general educational purposes and is not personalized investment advice. Each individual's financial situation is unique, and we recommend consulting with a Certified Public Accountant (CPA) or tax expert to discuss your specific circumstances and determine if your child is eligible to contribute to a Roth IRA.

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