Roth IRA for Kids

Opening an IRA for kids is a wise financial move. Roth IRAs offer unique benefits for savers of all ages, and kids have plenty to gain by investing early.

Regardless of age, your child can contribute to an IRA as long as they have earned income, stated by the IRS, "all the taxable income and wages you get from working...for someone who pays you or in a business you own."

It is also important to know that not just anyone can open a Roth IRA account for your child, and an adult custodian must set up the account for the benefit of a minor child.

An adult "custodian" may be any person over 18 who is legally responsible for the minor's support and well-being.

For example, if a parent wants to open an IRA for his child, the custodian could be that child's grandparent or even another family friend.

Types of IRAs for Kids

There are two types of IRAs available that you can open for your child: traditional and Roth.

Traditional IRA

In a traditional IRA, you will pay the taxes upon withdrawing of the money during retirement. Your contributions and the earnings they have accrued are pre-taxed in a traditional IRA.

A major benefit of a traditional IRA is that it offers tax-deferred growth.

Roth IRA

You pay taxes when you deposit the money into your Roth IRA account, so the funds - contributions and earnings - are considered after-tax money.

The advantage of Roth IRAs is that if a child withdraws the money several years later, he no longer has to pay taxes. Another advantage is that Roth IRAs have no required minimum distribution (RMD). Similar to traditional IRAs, the money grows tax-free.

However, it is critical to note that your child may be obliged to file an income tax return if their gross salary is beyond the certain amount set by the IRS. This rule applies even if your child claims that he is dependent.

How to Open a Roth IRA for Your Child

If you are ready to open a Roth IRA for your child, follow these steps:

Step 1: Determine Eligibility

Ensure that your child meets the eligibility requirements, including earned income. This information will be used to determine the amount of your child's maximum contribution.

Step 2: Choose a Custodian

An adult custodian must open the Roth IRA account, so you will need to find someone willing to act as the account holder.

You will need to provide information on the custodian, including their name and address. You may also be prompted to supply identification that proves you are the child’s legal guardian.

Step 3: Open an Account

Fidelity offers a Roth IRA specifically for children, but you can choose any broker that offers Roth IRAs. You will need to complete an application to open the Roth IRA account, and you will need to provide documentation for both the custodian and the child.

Step 4: Make Contributions

Each year, you will need to report contributions and earnings to the IRS. You may contribute up to the maximum limit each year. Your child’s age and earnings determine the contribution amount.

Step 5: Track Expenses

Keep track of qualified higher education expenses to use for withdrawals later on. These expenses may be used as a withdrawal source from your Roth IRA.

It is important to note that a Roth IRA for kids account is just like any other Roth IRA, and there are no special rules or benefits associated with it.

The money can be used for any purpose once it is withdrawn, so discuss expectations with your child.

Rules of Roth IRAs for Kids

• No age limit. Any child, regardless of age, may contribute to a Roth IRA. The obstacle to opening this account is income, not age.
• The child must have earned income. If the child earns, he can contribute to the Roth IRA. The IRS defines earned income as the income tax and wages — money earned from a W-2 job or self-employment gigs such as babysitting or dog walking.
• Contribution limits. In 2023, the Roth IRA contribution limit is $6,500 ($7,500 if age 50 or older), or the total annual earned income, whichever is less.

Benefits of a Roth IRA for Kids

Some key benefits to investing in a Roth IRA for kids include:

1. Tax-Free Growth: Contributions to a Roth IRA are made with after-tax dollars, so there is no immediate tax deduction. Withdrawals of earnings are legal without an income tax consequence, provided that your child's account is at least five years old and the purpose of the withdrawal is to pay for qualified college expenses.
   
   

2. No Required Minimum Distributions: The money in a Roth IRA can be left to grow until your child's retirement, so there is no need to start taking distributions at a certain age. This can be a big advantage over other retirement account options, requiring minimum distributions starting at age 73.
   
   

3. Flexible Withdrawal Options: Roth IRA money can be used for any purpose once your child is no longer a student. This gives your child the flexibility to use the funds for a down payment on a first house or early retirement.
   
   
4. Financial Literacy: Teaching your child the value of money and saving for his future is a great way to set them up for financial security.

The Bottom Line

A Roth IRA for kids is just like any other Roth IRA. You can put up to $6,500 into it every year, but the money must come from earned income.

The child's earnings can be deposited directly into the account or rolled over from a custodial account if you already have one opened on their behalf at another firm.

Remember that the Roth IRA is a tax-advantaged retirement account, so you must report contributions and earnings each year.

You can withdraw money using qualified higher education expenses as an excuse, but they will be taxed at your child's rate.

FAQs

1. What is Roth IRA?

A Roth IRA is an individual retirement plan that allows you to set aside money for retirement without worrying about taxes until it is time to withdraw the money.

2. Can you open a Roth IRA for your kids? 

Yes, anyone who meets the requirements may open a Roth IRA.

3. What are the benefits of a Roth IRA for kids? 

There are various benefits of a Roth IRA for kids, including tax-free growth and withdrawals for qualified higher education expenses, no required minimum distributions, and flexibility to use the money.

4. How much is the contribution limit to a Roth IRA for kids?

The maximum you can contribute to a Roth IRA for your child in 2023 is $6,500, and this limit increases each year until the child turns 18.

5. How do you set up a Roth IRA for kids?

You can open a Roth IRA for kids by contacting a financial institution and setting up an account. You must include the child's name, social security number, and date of birth on the account.