Should You Open a Roth IRA for Your Child

Should You Open a Roth IRA for Your Child

A Roth IRA is an excellent savings vehicle to take advantage of thanks to its tax treatment. Contributions are made with after-tax dollars, grow tax-free, and the growth can be withdrawn tax-free! Also, your contributions can be withdrawn at any time without tax consequences.

How can you help your child take advantage of this savings? There are a few considerations to note in making this decision.

  1. Your child must have earned income in order to contribute. Meaning they need a paper route, a babysitting gig, or some other employment from which they receive either 1099 or W-2 income.
  2. If your child has earned income, they can contribute the lesser of their annual gross income or the maximum contribution. In 2021, the maximum Roth IRA contribution for those under age 50 is $6,000
  3. Example: Your son, Joe earned $4,000 working at the baseball snack shack. He can contribute up to $4,000 to a Roth IRA in that year.
  4. The account would technically be a Custodial Roth IRA and must be opened by an adult a.k.a. you, their parent, a grandparent, etc. Once the child turns 18 (or 21 in some states), the account ownership will be transferred to their name.

Why should you open a Roth IRA for your child?

  1. You’ll be giving your child the gift of time in the market. The sooner they start, the sooner they can take advantage of compounding interest! Properly invested savings beats cash savings in the long-term any day.
  2. Although the name suggests this account is for “retirement”, there are no legal limitations stating it can only be used in retirement. Contributions can be withdrawn at any time, tax and penalty-free. Ideally, it’s great to let the tax-free growth ride for as long as possible, but funds can be withdrawn in the future for a home purchase, education, or anything else.
  3. You’re giving your child future tax flexibility of their income. When it comes to drawing income off your portfolio, it can be drawn in one of three ways for tax purposes. As ordinary income (from a 401k), as capital gains (sale of stock in a brokerage account), or tax-free (from a Roth IRA)!

These are just a few reasons why, if your child meets the qualifications of having a Roth IRA, it’s a great way to help set him or her up for future financial success. A custodial Roth IRA can probably be opened on your favorite platform – Vanguard, Fidelity, Schwab, etc.

For help navigating savings and investing for your child’s future, get in touch with us and together we’ll develop your very own Money Roadmap!

MainStreet Team
MainStreet Team

MainStreet Financial Planning, Inc., an independent fee-only financial planning firm was founded in Maryland in 2002 by Jim Ludwick, CFP® who passionately believed that financial planning advice should be accessible to people from all walks of life without product sales and investment management services. In 2006 Anna Sergunina, CFP® joined the team and together they grew MainStreet Financial to a nationally recognized company, with a team of 6 staff members and 5 offices across the country.

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