kids Roth IRA

Want To Open A Kids Roth IRA? Here Are The Facts!

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Have you thought about opening a Roth IRA for your kid to give them a headstart on saving for retirement? Opening a custodial Roth IRA account for your kid can mean that they will benefit from decades of compound interest. It can be a great way to introduce the concept of saving and investing to your child. However, there are a few things you need to think about before you open a kids Roth IRA.

Can you do a Roth IRA for a child?

Yes, it’s possible to open a Roth IRA for a child, as long as the child has earned income.

How does a kid Roth IRA work?

Roth IRAs for kids, also known as custodial Roth IRAs, work exactly the same as a normal Roth IRA. Only earned income can be contributed to a Roth IRA and the account requires an adult to open on behalf of the child.

The most important thing to note is that your kid must have earned income for that specific year.  Earned Income is defined by the IRS as “all the taxable income and wages you get from working […] for someone who pays you or in a business you own.” Money from an allowance or investing income does not count as earned income. 

What age can I open a custodial Roth IRA for my child?

There are no age restrictions. Your child can open a Roth IRA as long as they have earned income regardless of their age. 

How can I open a custodial Roth IRA for my child?

Roth IRAs generally require an adult to open. Fidelity, Schwab, and E*Trade offer custodial Roth IRA accounts. The process to open a Roth IRA is very simple. The adult then manages the custodial Roth IRA on behalf of a minor until they reach the age of majority. The age of majority is dependent on the state that the child lives in.

Kids Roth IRA contribution limit 2024

The Roth IRA contribution must not exceed the child’s earned income. The contribution limit for a custodial Roth IRA for a child in 2024 is $7,000. For example, if your child earns $3,000 in 2024, then they can only contribute $3,000 to their Roth IRA for 2024. If your child earns $10,000 in 2024, then they can only contribute $7,000 to their Roth IRA for 2024.  If your child has no earned income then they cannot contribute to a Roth IRA. 

 

Can parents contribute to a Roth IRA for a kid? 

Yes, direct contributions to a custodial Roth IRA can be done by parents or someone else. Many parents choose to match their child’s earnings and make the IRA contribution themselves. For example, if your child earns $2,000 at a summer job, you can let them spend their money as they wish and make the $2,000 Roth IRA contribution with your own money.

It is also important to remember that the Roth IRA contribution must not exceed how much your kid made that year. Therefore, if your kid made $2,000 then only $2,000 can be put into the Roth IRA by either yourself, someone else or your kid.

Can others contribute to a kids Roth IRA?

Yes. Direct contributions to a child’s Roth IRA can be a gift from anyone. The IRS doesn’t care who makes the contribution as long as it doesn’t exceed your child’s earned income for the year.

Does household chores count as earned income?

No, you cannot pay your child for “normal household chores” and then invest that into a custodial Roth IRA. The safest way to invest into a Roth IRA is for your child to have earned income.

If I have my own business, can I start a Roth IRA for my child?

If you have your own business, then you can employ your children and pay them an income at the market rate. This earned income can then be invested into a custodial Roth IRA. 

Here are some specific steps that you can take:  

  1. Create a business entity, get an employer ID and start generating revenue into a business bank account.
  2. Create a job description for your kid and pay them at least the minimum wage required by your specific state.
  3. Pay them with a W-2 payroll check. 
  4. Use up to $7,000 of their earned income per year to invest in their custodial Roth IRA.

>> Want to take a proactive step towards shaping your financial future? Book a FREE discovery call now and learn how we can help you on your journey to financial success.

How do I prove my child’s income for a Roth IRA?

Ideally your child should have a W2 or a Form 1099 to show evidence of the earned income. However, there are some instances where this may not be possible so it’s important to keep records of the type of work, when the work was done, who the work was done for and how much your child was paid.  Some examples of work that may not have a W2 or Form 1099 include if your child is mowing the lawns for your neighbor or if they are working for your family business. 

Does a kid Roth IRA affect financial aid?

Retirement accounts aren’t reported as assets on the Free Application for Federal Student Aid (FAFSA). Therefore a Roth IRA will not affect financial aid.

Is a Roth IRA good for a child?

There are many benefits of opening a Roth IRA for a kid.

  • Compound interest: Your kid’s Roth IRA will benefit from many years of compound interest which will help set them up for retirement.
  • Financial Literacy: Opening a Roth IRA for your child helps them learn more about finances and saving for their retirement.  It can help them learn more about earning, spending, saving, and also the power of compounding. 
  • Contributions can be withdrawn at any time: Any money that is contributed to a Roth IRA can be withdrawn at any time without the 10% penalty. This is generally not the best practice but it is an option. If the child withdraws the earnings, then that money is subject to a 10% penalty fee and may be taxed as income. 
  • Education expenses: Your child can withdraw the money for college. There is no 10% early withdrawal penalty if the money is used for qualified education expenses. However, they will need to pay taxes on their earnings. This is not the best option for saving for college, but it is still an option to consider.
  • Buying a house: After the Roth IRA has been open for 5 years, your child can withdraw $10,000 as payment towards their first house.  This must be used for a down payment or for closing costs. The $10,000 withdrawal is tax-free and penalty-free.

Can I leave my Roth IRA to my child?

Yes, you can leave your Roth IRA to your child as part of your estate planning. When you pass away, your Roth IRA can be transferred to your child as a beneficiary. However, there are some important considerations to keep in mind so it’s advisable to consult with a fee-only financial planner.

Kids Roth IRA versus Traditional IRA

A custodial IRA can be either a Roth or traditional IRA

Roth IRAs are funded with after-tax money. Consequently, your contributions are always accessible for withdrawal at any time, free from taxes and penalties. However, earnings on the account may incur penalties and taxes if withdrawn before reaching age 59 1/2.

In contrast, traditional IRAs receive pre-tax contributions, which are then taxed upon withdrawal. While traditional IRAs effectively reduce taxable income today, this might not be the most efficient use of a custodial investment account, especially considering that most children earn minimal income and consequently pay little tax. 

Opting for a Roth IRA rather than a traditional IRA might be preferable for children.

Open a kids Roth IRA and benefit from compound interest

Get a head start on retirement savings and wealth building for your children. While your child may not want to invest their money right now, they will thank you later. There is a huge advantage to opening a Roth IRA early since your child will benefit from decades of compound interest. If you want help with your finances and are interested in having a comprehensive financial plan for your family, feel free to schedule a discovery call with one of our financial advisors today!

Best Financial Planner Washington DC

Alvin Carlos, CFP®, CFA is an investment advisor and fee-only financial planner, in Washington, D.C that works with clients across the country. He has a Master’s degree in International Relations from SAIS-Johns Hopkins. Alvin is a partner of District Capital, a financial planning firm designed to help professionals in their 30s and 40s achieve their financial goals through smart investing, reducing taxes, retirement planning, and maximizing their money. Schedule a free discovery call to learn how we can help elevate your finances.

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District Capital is an independent, fee-only financial planning firm. We help professionals and entrepreneurs in their 30s and 40s elevate their finances and maximize their money. We are based in Washington, D.C and we work with people virtually nationwide.

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