Starting a Roth IRA for your child
If you want to give your child or grandchild a financial head start, consider starting a Roth IRA for them. Not only will this help prepare them for retirement early on, but it will also give them the opportunity for extra support during qualifying life events.
Setting up their Roth IRA
Setting up a Roth IRA for your child is often referred to as a custodial IRA, assuming they’re still a minor. Because of this, you will act as the custodian of the account until they are able to take it over. In this case, individual state laws determine when the minor is capable of managing the account for themselves.
Once your child has an earned income, you can begin setting up their Roth IRA. Bear in mind, their maximum annual contributions cannot exceed their earned income. For example, if your child earns $4,000 working during the summer, then their maximum contributions for the year will be $4,000.
You can also help contribute to your child’s Roth IRA, but again these contributions cannot exceed their earned income. Your contributions to your child’s Roth IRA can also count as a gift within your $15,000 yearly gift tax exclusion. Married couples have a $30,000 yearly gift tax exclusion.
Preparing for the future
Typically, if money is withdrawn from the Roth IRA before the age of 59½, it will be subject to a 10% federal tax penalty. That being said, there are a few notable exceptions. During certain major life events, like buying a first home or paying a college tuition, the IRS may waive the pesky early withdrawal penalty.
As with normal Roth IRAs, tax-free and penalty-free withdrawals cannot occur unless your child has reached the five-year holding requirement and is above the age of 59½.
The great advantage of starting early
Giving your child this financial head start comes with several great advantages. It not only introduces them to basic and important financial concepts at a young age, but they also get the incredible benefit of long-term compound interest.
Giving your child this hands-on learning experience will not just give them a financial head start, but also help them fundamentally understand the value of saving for the future and help them develop useful financial habits.
This article should not serve as a replacement for real-life advice. Always consult a professional before making a serious change to your investment strategy.