How to Use a Roth IRA as a Retirement Savings Vehicle for a Child


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Many people think of Roth IRAs as an adult retirement savings vehicle. But children who earn an income can also save for their retirement through this tax-efficient savings vehicle.

This year’s Roth IRA contribution limit is $6,000 for people under age 50. A person whose income is less than that for the year can contribute all of his earned income. Earned income refers to money earned from employment or self-employment, which includes a paid position in a family business.

There is no minimum age to contribute. So, for example, if a 14-year-old earns $500 as a camp counselor or a 16-year-old earns $3,000 as a lifeguard, or a 10-year-old earns $300 as a storekeeper for a family-owned bodega, each can contribute up to that amount to a custodial Roth IRA opened by a parent for the benefit of the child. A Roth custodial account only takes a few minutes for the parent to open at an online brokerage such as Schwab or Fidelity.

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It’s also a simple transfer process once the child reaches the age of majority, usually 18 or 21, depending on the state.

Yet many people don’t realize that these types of accounts exist and the multiple benefits they offer, including decades of tax-sheltered growth. “Opportunity costs are one of the biggest costs,” said James A. Colavita, certified financial planner at GenTrust in New York.

Here are three reasons to open a custody Roth in your child’s name:

Tax-free investment growth potential

Money in a Roth IRA is paid after tax, and you can withdraw contributions made to a Roth IRA at any time without worrying about taxes or penalties. If you withdraw money before age 59.5, you face taxes and a penalty on your earnings, with some exceptions. These exceptions could provide additional incentive for children who may be reluctant to be asked to set aside their hard-earned money for 50 or 60 years.

For example, they could use up to $10,000 for a first home, tax and penalty free, provided the account has been established for at least five years. They might also decide to use Roth money for qualified education expenses. This will avoid the 10% penalty, but they will still pay tax on the portion of the income.

Plus, because it’s a Roth, the IRS doesn’t require mandatory distributions at age 72 like a traditional IRA. So the money can keep growing longer, said Keith T. Barberis, managing director and partner at Barberis Wealth Management in Bethesda, Maryland.

Benefits of compound interest for children

“Time is your best friend or your worst enemy when you’re an investor,” Colavita said. “If you start early, time is your best friend.”

Daniel Hawley, Certified Financial Planner at Hawley Advisors Wealth Planning in Walnut Creek, Calif., offers the hypothetical example of a child who starts saving at age 10 and contributes $500 a year for eight years. Assuming a 9% ROI, the child would have a nominal account value of approximately $478,000 at age 67. That translates to an inflation-adjusted value of about $142,500, using a constant inflation rate of 2.5%, according to his figures.

If the child had contributed $1,500 per year during the same period, the account would have grown to about $1.4 million by age 67, or about $407,000 adjusted for inflation. “It’s a fabulous wealth-building mechanism. The earlier you start, the less you have to contribute in the background,” Hawley said.

Additionally, due to the long lead time to retirement, children should be invested aggressively, Hawley said. “You don’t want to sit in a low-risk balanced fund,” he said.

Teach personal finance early

There has been greater pressure in recent years to ensure children learn financial literacy skills in school. Among states requiring personal finance education in high school, nearly one in four students will take a related course before graduating this year, according to the 2022 Next Gen Personal Finance State of Financial Education report.

Even so, many children don’t have a basic understanding of investment concepts or the skills needed to be prudent investors – and they don’t necessarily learn the skills at home.

Yet 93% of teens believe they need financial knowledge and skills to achieve their life goals, and 97% of parents share this sentiment, according to a March survey from Greenlight Financial Technology.

This is where something like a Roth IRA can be a wonderful teaching opportunity — both from an investment and work ethic standpoint, the advisers said. “It teaches them about investing, the benefits of compounding, healthy investing habits, and it motivates them to work,” Barberis said.

Another benefit is the ability for parents, grandparents, family or friends to contribute the full amount or part of it on behalf of the child. This could help a child who is reluctant to part with some or all of their income, and it also gives them a financial boost for the future.

“It says to the kid, ‘Wow, that’s really important because my parents don’t always like to give me money for everything, but they give me money for that,'” Colavita said. .

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