Most kids don’t think about retirement or fully understand it, but as parents, you can open a minor Roth IRA for your child and start their retirement funds early. An IRA can be one of the greatest gifts you give your child, even if they don’t understand or recognize it yet. Then, when they hit adult years and realize the value of what you’ve done, they’ll be grateful.
What Is a Minor Roth IRA?
A Custodial Roth IRA for kids is just like a regular IRA for adults. It sets aside money after-tax for retirement. If you start a Roth IRA for your child now, it has up to 47 years to grow, depending on what age you start it.
The funds grow tax-free, and as long as your child doesn’t withdraw money until age 59 ½ or older, the money withdrawn is tax-free too.
How Does It Work?
To open a minor child’s Roth IRA, your child must earn income. It doesn’t matter where they work. It could be for the local ice cream shop, babysitting for a neighbor, or cutting lawns — it all counts.
As long as your child claims the income and pays taxes on it, they can contribute funds to a minor Roth IRA. The funds that are deposited into the custodial Roth IRA are post-tax. This means that it is not considered taxable income when they withdraw it in the future. So, the tax advantages of not having to pay income tax in the future with higher rates is a great bonus. Like adult IRAs, minors can contribute up to $6,000 per year in Roth IRA contributions, but no more than they earn. Once your child is over 18, they must convert the account from a custodial Roth IRA or minor account to a standard Roth IRA.
What’s the Difference Between a Minor Roth IRA and a Minor IRA?
A minor Roth IRA and traditional IRA are both retirement accounts that set your child up during retirement, but some major differences are.
Traditional IRA Funds Are Pre-Tax
Your child will get the tax break in the year they contribute to a traditional IRA versus contributing post-tax in a Roth IRA. This lowers your child’s tax liability today but likely increases the amount of taxes they will pay in retirement. Chances are your child is in a much lower tax bracket today than they will be during retirement. This could mean paying more taxes on the funds.
Roth IRAs Don’t Have Required Minimum Distributions
Traditional IRAs require retirees to take out a certain amount of their retirement funds every year after age 72. This can cause a higher tax liability than anticipated. Roth IRAs don’t have required distributions which allow retirees to plan their withdrawals better to minimize their tax liabilities.
Who Else Can Contribute to a Minor Roth IRA?
Anyone can contribute to a minor Roth IRA for kids. However, the total contributed cannot exceed the child’s total earnings or $6,000 per year, whichever is less.
For example, if your child earned $3,000 this year, you or your child (or anyone else) can contribute a maximum of $3,000.
Some parents match their child’s contribution or even let their child do what they want with the money earned, while the parent contributes the amount they earned to their Roth IRA.
Does a Minor Roth IRA Affect a Child’s Financial Aid?
Most assets affect a child’s ability to secure financial aid for college, but retirement assets are exempt from this requirement. You or your child don’t have to disclose retirement assets, so it won’t hurt your child’s ability to get financial aid.
A minor Roth IRA is a great way to set a child up for financial success. Even if your child can’t afford to contribute to the account straight out of college, they will have the foundation set for them already.
If you set up an IRA for your child around age 14–15 when they start working, that gives them a nice head start on their retirement funds. With more time for the earnings to compound, your child will have a nice nest egg by the time they can afford to contribute to the account too. This content was originally published here.