We all want to give our kids the best life possible, and a big part of that is helping them learn to save money and handle their finances responsibly. As a parent, you want to make sure that your child’s financial future is stable and that they are able to retire comfortably someday. If your children are still minors, their retirement is decades away, and you may not even be around to see it. So, how can you help them get there?
My kids are just teenagers. Why should they be investing for retirement?
There are a few different reasons that it’s a great idea for people to start saving for retirement while they’re still kids. The first is simple math. The earlier your kids start to save, the longer their money will have to grow. It’s estimated that money invested doubles every ten years, which means that someone who starts investing for retirement at age 15 has a huge head start over someone who starts at 25 or 35.
How can a Roth help my child learn to invest?
Investing for retirement, and saving in general, is also a great habit to instill in your kids. By opening a Roth when they first start earning money, you can help them get into the habit of saving money out of every paycheck for their future. It can be a great opportunity to talk to kids about the importance of having savings to fall back on. It can also be a great chance to talk to them about the market and compound interest. With your help, your kids can be more prepared for the financial responsibilities of adulthood than their peers.
Will saving in a Roth reduce my kid’s eligibility for scholarships?
A great additional benefit is that retirement savings (of either the student or the parents) are not considered assets when colleges calculate financial aid. That means that putting money into a retirement account can keep your child eligible for more grants and loans than they would be if they put that same money into a savings account. Money distributed from the IRA would count as income.
Why is a Roth better than a traditional IRA for kids?
When you invest in a Traditional IRA, the money that is invested is pre-tax, and then you pay taxes on your withdrawals in retirement. For working professionals, this can be a good option – most people are in a higher tax bracket while working than they are in retirement.
Money that goes into a Roth is post-tax, and then all of the growth is tax-free. Since just one contribution of $5,000 can be expected to grow to about $160,000 in 50 years, this could save your child tens of thousands of dollars in taxes. Additionally, most kids and teenagers are in one of the lowest tax brackets, so they do not need to worry about finding ways to save on their taxes.
Who can contribute to a Roth IRA?
There are a couple of requirements that your child must meet to be eligible to contribute to a Roth IRA. They need to have earned income (and have filed taxes for that income), and not have that income exceed $135,000. Gifts, inheritances, and investment income do not count as earned income. If your child is a highly successful actor, entrepreneur, or other professional, they could earn too much to be eligible. However, just about any minor working a part-time job after school and during the summers would be eligible to contribute.
What is a Roth IRA invested in?
Like a 401(k), a Roth IRA is just an investment vehicle, and you (or your child) get to decide what it will be invested in. Your brokerage will likely have options for you to choose between – most experts recommend choosing a fund that tracks the S&P 500. You could choose to invest in specific individual stocks, but this is a much higher-risk option. With a timeline of half a century, it’s generally less risky to invest in a broader fund that tracks the entire market. That means that assuming the economy continues to grow throughout their lifetime as it has for the past century, your child can reap the benefits of that growth instead of staking their retirement on the success of just a few companies that might be long obsolete by the time they are ready to retire.
What if my child is under the legal working age?
In many states, employment laws prohibit children under the age of 15 from working. You might think that would mean that kids 14 and under can’t open a Roth IRA, but that’s not necessarily true. Jobs like babysitting and mowing lawns are exempt from this law, but keep in mind that your children would need to be reporting this income to the IRS in order for it to count. They should already be doing this if they earn more than $400 in a year.
There are a few ways that children under 15 can earn income. One of the most common is by working as an actor or model. If you know someone who owns a business, they can hire your child to model for advertisements and your child can then earn income.
Children are also allowed to work for a business that is wholly owned by their parents. That means that if you or their other parent is self-employed, you can hire your pre-teen to help you file papers or do other simple tasks. Just make sure that you pay them and file taxes for them.
Is there a limit to how much my child can contribute to a Roth?
Anyone can contribute either $6,000 per year (the amount is occasionally changed based on inflation, so always check on contribution limits) or their total earned income, whichever is smaller. At age 50, the maximum contribution increases by $1,000. If your child works 15 hours a week at $10 per hour, they would earn $7,800 in a year.
Some parents decide to fund the Roth themselves and allow their child to spend their own earnings. Others choose to match any amount the child contributes. Still, others choose to teach their children about the power of saving young and provide the opportunity but require them to contribute their own money entirely. The right choice for you depends on your family and your financial situation. Keep in mind that your own retirement is coming much sooner than your children’s, and never sacrifice your own retirement savings in order to help with theirs.
Can they use a Roth for anything other than retirement?
One of the great things about a Roth is that the withdrawal options are fairly flexible. Your child can withdraw their contributions at any time, with no penalty. They can withdraw earnings at any time as well but would be required to pay a 10% penalty.
There are a number of situations that are considered qualified distributions, where the 10% penalty does not apply.
- If your child becomes permanently and fully disabled, they can make withdrawals from their Roth without penalty.
- When your child decides to purchase their first home, they can withdraw up to $10,000 of earnings penalty-free, as long as the account has been open for at least five years.
- A Roth can be used to pay for education expenses (including tuition, books, fees, and more) without incurring a penalty, although they will need to pay taxes on the distributed earnings.
- In some cases, unemployed people can use their Roth to cover their health insurance premiums.
Of course, if they do choose to use the funds for retirement, any withdrawals after age 59 ½ are also tax- and penalty-free.
What happens to the Roth as my child ages?
If you open a Roth while your child is a minor, the account will be a custodial IRA. That means that the money is in their name, but you would have control of the account.
When your child becomes an adult, the account would be moved into their name. The exact mechanism of this depends on the brokerage, but all money in the account would be considered legally theirs.
Your child can either leave the account alone and allow it to continue to grow. They can continue to contribute to it throughout their career. As long as their income does not exceed the limits, they have the right to contribute to the Roth every year. They can contribute to a Roth in addition to contributing to a 401(k). Also, they would have the right to contribute the maximum to both accounts if they are an unusually dedicated saver.
People can contribute to a Roth as long as they have an earned income. Traditional IRAs do not allow contributions beyond age 70 ½ but that is not the case with a Roth. A Roth also does not have required minimum distributions.
If there is still money in the IRA when your child passes away. They can pass it on to their children or grandchildren without penalty. This means that by helping your child start a Roth IRA. You could be starting a ripple effect of wealth for generations of your family.
How can I open a Roth IRA for my child?
If your child is eligible for a Roth IRA and you’d like to open one for them, it’s very easy to do so:
- Check with your brokerage to see if they offer custodial IRAs.
- Have your child’s Social Security number, birthdate, and other identifying information on hand. You will also need your own information.
- Open an account in your child’s name. You will have control until they turn either 18 or 21 (exact age depends on the state you live in).
- Keep in mind that contributions are considered irrevocable for the benefit of the child. So do not invest money on your child’s behalf if you think you might need it back.
You might be long gone by the time your child is ready to retire. But if you help them open and fund a Roth IRA while they’re still a teenager. They’ll appreciate the gift many decades from now. Helping your children save for retirement is a wonderful legacy to leave. Opening a custodial Roth IRA is an easy way to ensure that they’ll be financially secure into their old age.