How to Jump-Start Your Child's Retirement
By Ryan Rink CFP®, ChFC®, CLTC®
One of the best retirement savings vehicles is the Roth IRA. With a Roth IRA, you make after-tax contributions, experience tax-free growth and have tax-free withdrawals (provided you take the money out after age 59.5 and satisfy a 5-year holding period).
Most of us don’t begin saving for retirement until we start our first full-time job. What you may not be aware of is that you are able to open a custodial Roth IRA account for your minor children (regardless of age), provided they have earned income. As a parent, you control the assets in the account until your child reaches majority age, which is 18-21, depending on which state you reside in. Once your child is of majority age, the account is re-titled and the assets are turned over to your child. It’s important to educate your child that even though they are able to withdraw the funds, it is to their benefit to leave them in the account to grow over time.
Roth IRAs make excellent savings vehicles for young people.
The tremendous power of compound growth is one benefit of starting the account while your child is young. For example, a single one-time contribution of $6,000 into a Roth IRA at age 15 could grow to over $110,000 when they reach age 65 (assuming a 6% annual compound rate of return). Since you have already paid taxes on the money you put into the account, your child will not have to pay income tax on this money when they withdraw it decades later. Opening a Roth account for your child also provides a great teaching opportunity by introducing them to saving and investing at a young age, helping them to develop healthy financial habits.
The maximum amount your child can contribute to a Roth IRA in 2021 is the lesser of $6,000 or their total taxable earnings for the year. For example, if your child is 15 years old and earns $5,000 throughout the year, they can contribute up to $5,000. If your child earns $8,000, they are able to contribute up to $6,000.
Another point to keep in mind is that parents, along with grandparents and other family members can help fund the account for the child, as long as they don't exceed the amount of your child's earned income or $6,000. Money from an allowance or investing income does not count as earned income and cannot be used toward contributions. Roth contributions can be a great option for grandparents looking to make a gift to their grandchild, as well as a real difference in their future. This will be a lasting gift that your child will look back on years later and truly appreciate the value of what you and/or their grandparents did for them.
Please contact your financial advisor for details and other rules regarding Custodial Roth IRA contributions and gifting.