Can you open a Roth IRA for your child?
The answer is yes – sort of. Unlike a fully taxable custodial brokerage account, which lets you invest on behalf of a minor, you can not open and fund a Roth IRA for your child. The key word being fund.
For example, with a taxable brokerage account, your newborn child’s grandma can set up an account in your child’s name and purchase any amount of stock she so chooses. But when it comes to a Roth IRA, your child needs to generate taxable earned income before you can help them set up an account, and most newborns don’t come with taxable income!
However, assuming your child does have taxable earned income, you can open a Custodial Roth IRA on his or her behalf.
No Roth IRA Age Limit
Most people fail to realize that no age restrictions exist when it comes to funding a Roth IRA.
Anyone, regardless of age, can contribute to a Roth IRA as long as they generate taxable earned income that falls within the Roth IRA income limits. To illustrate, let’s look at some extreme examples.
Let’s say you have a six-month old baby earning $10,000 per year modeling baby clothes for a national retailer. As long as you file an income tax return on behalf of your baby, your baby can make the maximum Roth IRA contribution of $5,000.
On the other end of spectrum, let’s say you’re 100 years old with a passion for power tools. You work part-time at Home Depot as a hobby and earn $14,000. You can make a $6,000 Roth IRA contribution, because anyone over 50 years old is allowed to make a $1,000 catch-up contribution.
Those are two extreme examples, but they drive home a key point – Roth IRA eligibility has nothing to do with age and everything to do with your ability to generate taxable earned income.
So, if you want to establish a Roth IRA for your child, they must have earned income. And their annual Roth IRA contributions can not exceed the amount of earned income they generate in any given year.
According to the IRS, earned income includes wages from a job, sales commissions, tips, and/or bonuses. Earned income does not include your child’s weekly allowance, gifts from grandparents, or investment income from a trust.
For example, let’s say your teenage son works part-time as a lifeguard. Over the course of the summmer, he generates $6,000 in after-tax income. Your son is eligible to make the maximum $5,000 contribution to his Roth IRA, but if he only earns $3,000, the maximum contribution he can make is $3,000.
Custodial Roth IRAs
With a Custodial Roth IRA, you oversee the management of your child’s Roth IRA until he or she reaches the age of majority (anywhere between ages 18 and 21 depending on the state in which you live). This means you have the power to determine how your child’s money is invested. You can initiate buy and sell orders for stocks, mutual funds, ETFs, etc. You can do anything on their behalf that you can do with your own Roth IRA, except – withdraw money.
Unlike your own Roth IRA (which allows you to withdraw your original contributions tax-free and penalty-free at anytime and for any reason), the Roth IRA withdrawal rules state that money can not be withdrawn from a Custodial Roth IRA under any circumstance until the owner (your child) reaches the age of majority. And that leads us to the next factor you need to consider…
They Own It, Not You!
While a Custodial Roth IRA gives your child an enormous head start in saving for retirement, it comes with a potential drawback. Your child owns it outright. And just like a taxable custodial brokerage account, once your child reaches the age of majority, they take over control of the account. At that point, they can withdraw every last penny if they choose, and this opens the door to the possibility they might squander their head start on retirement.
After all, thousands of dollars can be quite tempting to a young adult, especially if they haven’t fully matured. But keep in mind, this isn’t necessarily a bad thing. Your child can learn a valuable lesson from blowing a small fortune, and the earlier in life they learn this lesson, the better it will serve them in the long-run.
Giving Your Child A Head Start
Ask most people in their 40’s and 50’s which financial decision they most regret, and the overwhelming majority will tell you, “Not saving for retirement earlier in life.”
After all, it’s so much easier to save what you need for retirement if you start the process earlier. Why? The power of compound interest. And when it comes to compound interest, time is literally money.
To illustrate, let’s pretend two people are both saving $10,000 a year for retirement with a goal of retiring at age 65. Both manage to earn a 10% annual return, but Saver #1 starts at age 25 while Saver #2 starts at age 35.
At age 65, Saver #1 has $4,878,518.11, while Saver #2 has $1,819,434.25. That’s a $3,059,083.86 difference! Just to equal Saver #1’s retirement nest egg, Saver #2 needs to save an extra $18,596.93 per year – just because he started ten years later.
Now, pop open your Roth IRA calculator and imagine the possibilities if your child starts contributing to retirement at age 15. Your child will have an enormous head start financially, and they’ll have you to thank for encouraging them to save early!
This is an article from Britt at Your Roth IRA, the Web’s #1 resource for Roth IRA information.
11. That’s how old my daughter was when I opened her Roth. She has baby sitting income to justify and other money she’d get at 21 anyway, so this money in the Roth is no more or less frozen.
I figure she might graduate college with $50K+ in the account, more than many have in retirement accounts as full grown adults. 30 years at 10% is just under $900K by age 50. That would be sweet for her.
Brent Pittman says
I think the hurdle is how to get earned income for our children as early as possible to make them eligible for the ROTH.
This is so helpful! My daughter started doing a little modeling at three months old and has had a couple of jobs since then. I wanted to save the money for her, but I wasn’t sure what I should do with it. I am going to follow this advice. Thanks!
Sean H says
What’s your opinion on the percentage amount we should put into a ROTH? With such uncertainty in the future I feel we should be cash heavy. What’s your take?
@SJo – Just make sure you file a tax return on your daughter’s behalf. If it’s the type of income where she’ll receive a W-2, then you shouldn’t have any problems. Otherwise, make sure you personally report her income to the IRS.