Does a child who is 40+ years from retirement need a retirement savings account? At first, the idea could sound unnecessary. But a Roth IRA can give a younger loved one a major leg up in building wealth while helping them develop a strong work ethic and financial habits. Let’s explore this topic in more detail.
Roth IRAs for Kids
Roth IRAs can be opened and managed for a minor, typically by a parent. The parent makes decisions about contributions, investments and distributions, but the child owns the money in the account and gains control at age 18 in most states (check your state for age of majority rules). Because Roth IRAs give their young owners an early start to tax-free growth, they can be very effective instruments for building wealth.
Why Start so Early?
Roth IRAs are funded with after-tax dollars, and their earnings grow tax free. That tax-free growth can lead to impressive compounding. For example, a child contributes $5,000 a year from age 10 to age 18. Assuming a hypothetical 7% annual return, the child will have an account balance of $59,889 by age 18. If the account owner never adds another dollar to the account after their 18th birthday, the balance could reach $1,440,073 by the time he or she is age 65, again assuming a continued 7% annual return.
The Downside
Roth IRA contributions can be withdrawn at any age (tax and penalty-free), but earnings generally can’t be withdrawn without penalty until age 59½. With that being said, there are a few exceptions to these rules… Earnings can be used to pay for qualified education expenses, to buy a first home, pay certain medical bills, along with a few other exceptions.
How Can Kids Meet the Earned-Income Requirement?
The catch is that kids need “earned income” to have contributions made on their behalf. The contribution limit for a given year is the lesser of the child’s earned income or the IRA contribution maximum, which for 2024 is $7,000.
This begs the question… How can a minor earn thousands of dollars a year? Some summer jobs are now paying $15 to $20 an hour which makes me feel old. I remember my first summer job working construction where I made less than $10/hour! While younger kids are typically not eligible to work traditional W-2 jobs, they can still have other jobs including babysitting or doing paid tasks around the house.
Another Tax Return?
It is important to note that you will need to file a tax return or keep detailed earned-income records to support the Roth IRA contribution. A CPA will be able to let you know if the income is subject to self- employment tax. We always recommend running a strategy like this by your CPA before making any decisions.
Motivating the Next Generation
One way to encourage the next generation to get excited about Roth IRA contributions is to offer a match of their earnings with the goal of acquiring something they crave. For example, for each dollar your child earns toward their Roth IRA, you might contribute $2 to their car purchase fund. This is something Randy did for me many years ago so I can attest that it works. This approach can help kids learn the value of hard work and delayed gratification. If you’d like to learn more or move ahead with a Roth IRA for your child or grandchild, don’t hesitate to give us a call.
About the Author
Matt Price serves as a Partner and Managing Director for The Price Group of Steward Partners. He resides in Houston with his wife, Emily, their four children and "Fisher" the family golden retriever. Matt studied at the University of Pennsylvania – Wharton School of Business for his Certified Investment Management Analyst (CIMA®) designation after receiving his undergraduate degree from the University of Tennessee - Knoxville. Over the past 12 years, Matt has helped families make high quality, common sense decisions regarding their wealth and their legacy. Matt firmly believes everyone needs a wealth coach!
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The views expressed herein are those of the author and do not necessarily reflect the views of Steward Partners or its affiliates. All opinions are subject to change without notice. Neither the information provided, nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. Past performance is no guarantee of future results.
Steward Partners and its Wealth Managers do not offer tax advice; investors should consult their tax advisors before making any tax-related investment decisions.
The examples in this article do not take into consideration taxes, fees, and other money that is needed to invest which may reduce any outcomes. It can also be difficult due to market fluctuations to meet or beat any annual returns mentioned in this article. Actual results will vary.
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