What is a Roth IRA for minor children?
A Roth IRA for a minor child is a retirement account set up by parents, or guardians, that is controlled by the parent, but assets are in the name of the child. The custodially owned ROTH IRA operates under the same rules as a “regular” Roth IRA but is established, and managed, by the parent until the child reaches the age of majority, usually 18 or 21, depending on the state. This account offers an early start in saving for retirement and provides a potentially powerful advantage due to the long-term, tax-free growth, spanning decades.
Benefits and Why You Should Start One
We all want to get our children off to the best possible start and set them up for success later in life. Establishing a Roth IRA for a minor child is an excellent opportunity to teach a child about the importance of saving and investing for the future. As a young person, saving money is not instinctual and often the last thing on their mind, but what young people have on their side is time. The earlier the ROTH contributions begin; the more time funds can benefit from investment performance and compounding interest. Even small contributions have the potential to grow significantly with such a large time horizon.
Tax Considerations
For the child to be eligible for this type of account, he/she must have earned income, as defined by the IRS, as “taxable income and wages”. This includes earned income from W-2 employment, self-employment (such as babysitting or dog walking); or a parent/guardian, who owns their own business, may also consider hiring the minor child for employment. The annual Roth IRA contribution limit is $7,000 for 2024, or the total (child’s) earned income for the year, whichever is less. You may fund the child’s Roth IRA, for the prior tax year, until April 15th of the current year.
One key benefit to establishing a Roth IRA, minor or regular, is that assets within a Roth IRA can grow, and later be distributed, tax-free. A tax-free distribution is available upon the account owner attaining age 59 ½ and holding the account for five years. While Roth IRA contributions can be distributed at any age, time, or for any reason without being assessed tax or penalty; distributions made prior to age 59½ that include earnings will generally be subject to income tax and a 10% penalty tax, unless an exception applies.
Transferring the account to the beneficiary at age of majority
When the child reaches the age of majority (usually 18 or 21, depending on the state), the custodial Roth IRA must be transferred into a ROTH IRA that the now adult child owns. The minor ROTH IRA is legally transferred to the adult child’s ROTH IRA. Under this new account, the adult child will fully control the investments, contributions, and distributions. The adult child can continue contributing to the Roth IRA for their lifetime, provided they have earned income.
Conclusion
Starting a Roth IRA for a minor child is a powerful way to set the next generation up for financial success in retirement. By leveraging the benefits of tax-free growth, extensive time horizon, and potential of compound interest, the parent can provide their child with a significant head start on retirement savings. Additionally, the investment process offers a valuable lesson in financial responsibility to the child for their lifetime. Feel free to contact us if you would like to help your child with a head start on achieving financial independence.
Advisory services offered through Commonwealth Financial Network®, a Registered Investment Advisor.