Investing in a retirement account for your kid might sound insane, but it’s one of the easiest ways to transfer and build generational wealth, and a Roth IRA for kids can be a good start. You can consider opening a Roth IRA for your kids to help them prepare for their financial future and the benefits of saving early in life.
It also creates a financial safety net for them that can be used for major life expenses like college, a home purchase, or retirement. Plus, with the power of compounding interest, your child’s savings can grow significantly over time.
While money in a Roth IRA account is easier to withdraw once you’re 59½ years old, contributions to a Roth IRA can be withdrawn without taxes or penalties at any time. Also, if your child is able to contribute to a Roth IRA while still in high school or college, they’ll have millions of dollars in tax-free income in retirement if they leave that money untouched.
What Is a Roth IRA for Kids?
A Roth IRA for kids is commonly called a custodial Roth IRA for kids. A custodial account is one that is opened and managed for a child by an adult (the custodian), usually a parent. The child gets full control of the account once they reach between the age of 18 and 25, depending on the state.
The money in a custodial account belongs to the child at all times. The tough thing about custodial Roth accounts is that you can only make contributions if your child earns income.
If your child works during their younger years, or if you want them to get a summer job as teenagers, you will be able to contribute to their Roth IRA up to the yearly contribution maximum ($6,500 in 2023) of the earned income.
If your child is able to contribute $24,000 to a Roth IRA by the time they become 18 years old, it can grow to an impressive amount when they reach retirement age.
That $24,000 invested in a top low-cost index fund—like the Fidelity Total Market Index Fund (FSKAX), earning an average annualized return of 7.99% since its founding in 1997—will be worth $1,025,507.47 when your child turns 65. That’s tax-free money without ever having to contribute another dime after the age of 18.
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How to Open a Roth IRA for Kids
Opening a Roth IRA for kids is a simple process, but there are a few steps you should take to make sure everything is set up properly.
- Make Sure Your Child Earns an Income: In order to make contributions to a Roth IRA, a person must have earned some income. This rule applies to both adults and children.
- Find a Financial Institution: Some institutions also specialize in offering the best Roth IRA for kids. For instance, companies like Fidelity, Charles Schwab and Vanguard are good choices.
- Open an Account: Be ready to provide the child and custodian’s names, addresses, date of birth and Social Security numbers.
- Fund the Account: Decide how much to be contributed; it could be up to 100% of the child’s earned income or the $6,500 annual limit, whichever is lower. Using an electronic transfer from a bank account is the easiest way to do this.
- Invest Your Contributions: It takes a few days for funds to clear the account before you can start investing them. Set a calendar reminder to make sure you don’t forget and leave the money earning almost no interest for decades.
Since your child has a long enough time period to weather ups and downs, low-cost exchange-traded funds (ETFs) or mutual funds that invest in the entire S&P 500 or the entire U.S. stock market would be a good choice.
What Are the Rules for a Roth IRA for Kids?
Though it’s quite easy to set up a Roth IRA for kids, there are some rules and guidelines that you must follow:
- There is no minimum age limit to contribute to a Roth IRA for kids. An infant can contribute up to the annual limit to their Roth IRA if they are chosen as the next Gerber Baby and make $10,000 in their first month of life.
- The contribution limit is $6,500 per year, or 100% of the child’s earned income, whichever is lesser.
- Gift income does not count toward earned income for contribution eligibility.
- Contributions are not eligible for tax deductions.
- Growth in the account and qualified distributions are not subject to taxes.
- Contributions can be withdrawn anytime without penalty.
- Except in some cases, earnings cannot ordinarily be withdrawn without penalty until your child turns 59½ years old.
- Up to a certain amount of earnings can be withdrawn without penalty for a variety of purposes, like paying for college, buying a first home, certain medical bills, or any purpose following a total and permanent disability.
- Early withdrawals of earnings that do not qualify for one of the exceptions are subject to an IRS penalty tax of 10% plus any applicable income taxes.
- When the child reaches the age of majority in their state, the custodian can no longer control the account.
- Until tax laws change, the child will never have to take the required minimum distributions from the account in retirement.
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Benefits of a Roth IRA for Kids
There are many benefits that come with a Roth IRA for kids that go beyond just retirement savings. Here are some key benefits:
- Tax-Free Growth: The money in a Roth IRA grows tax-free since contributions are made with after-tax dollars. Your child won’t be responsible for paying taxes on the earnings as long as the money is used for qualified purposes, including retirement.
- Flexibility: The main goal of a Roth IRA for kids is retirement savings, but your child can use the money without facing penalties for other major life expenses like a Roth IRA for kids college (Roth IRA for kids education) or buying their first home.
- Compounding Interest: Your child can benefit from compound interest if a Roth IRA is opened for them at an early age. When money is invested for an extended period of time, it has more time to grow and could result in sizable savings by the time the person reaches retirement.
Why You Should Consider Starting a Roth IRA for Kids
A Roth IRA for kids is more than just a retirement account; it is an investment in their future. If you want to give your child the best possible start in life in terms of finances, you should consider starting a Roth IRA for kids.
There are many benefits to it, and if you start your child off early, you can help them build wise money habits. You can also provide them with the financial foundation they need to prosper in their adult lives.
A Custodial Roth IRA for kids will give your child a head start on retirement savings. While the money may start small, there is a great chance for future profit, especially if started early in life. It’s never too early to start planning for your child’s financial success!
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