How to Use a Roth IRA as a Retirement Savings for a Child

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Many people think of Roth IRAs as an adult retirement savings vehicle. But kids who earn an income can also save for retirement with this tax-advantaged savings tool.

The Roth IRA contribution limit for this year is $6,000 for people under 50. A person who earns less than that for the year can contribute to his/her total income. Earned income refers to money earned from a job or independent business, which includes a paid job at a family-owned business.

There is no minimum age to contribute. So, for example, if a 14-year-old earns $500 as a camp counselor or a 16-year-old earns $3,000 as a lifeguard, or a 10-year-old earns $300 as a shelving for a family-owned bodega, Each can contribute up to this amount to a Roth IRA that a parent has opened for the benefit of the child. A Roth Guardian account only takes a few minutes for the parent to open at an online broker such as Schwab or Fidelity.

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It’s also a simple transfer once the child reaches adulthood, generally 18 or 21, depending on the situation.

However, not many people realize that these types of accounts exist and the multiple benefits they provide, including decades of tax-free growth. “Opportunity costs are among the largest available,” said James Colavita, a certified financial planner with GenTrust in New York.

Here are three reasons to open a Ruth nursery on behalf of your child:

The possibility of investment growth is tax free

Money is contributed to a Roth IRA after taxes and you can withdraw contributions to a Roth IRA at any time, without worrying about taxes or penalties. If you withdraw money before the age of 59 1/2, you face taxes and a penalty on your winnings, with some exceptions. These exceptions can provide an additional incentive for children who may decline their claim to withdraw their hard-earned money for 50 or 60 years.

For example, they can use up to $10,000 to get a first home, zero taxes and no penalty, as long as the account has been in place for at least five years. They can also decide to use Roth’s money to cover expenses for qualified education. This will avoid the 10% penalty, but they will still pay income tax on the earnings portion.

Also, because it’s a Roth, the IRS does not require mandatory distributions at age 72 like a traditional IRA. The money can keep growing for longer, said Keith T. Barberis, managing director and partner at Barberis Wealth Management in Bethesda, Maryland.

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Advantages of compound interest for children

“Time is your best friend or your worst enemy when you are an investor,” Colavita said. “If you start early, time is your best friend.”

Daniel Hawley, a certified financial planner with Hawley Advisors Wealth Planning in Walnut Creek, California, provides the hypothetical example of a child starting saving at age 10 and contributing $500 annually for eight years. Assuming a 9% ROI, the child would have a nominal account value of about $478,000 at age 67. This translates to an inflation-adjusted value of about $142,500, using a constant inflation rate of 2.5%, according to his numbers.

Had the child contributed $1,500 a year during the same time period, the account would have grown to about $1.4 million by age 67, or about $407,000 adjusted for inflation. “It’s a great mechanism for building wealth,” Hawley said. “The earlier you start, the less background you contribute.”

Holly also said, because of the long time frame until retirement, children need to be invested aggressively. “You don’t want to sit in a balanced, low-risk fund,” he said.

Teaching personal finance early

There has been a greater push in recent years to ensure that children are taught financial literacy skills at school. Among the states that require a personal finance education in high school, Approximately 1 in 4 students They will take a related course before they graduate this year, according to the 2022 Next Gen Financial Personal Finance State of Financial Education report.

However, many kids don’t have a basic understanding of investing concepts, or the skills needed to be prudent investors—and they don’t necessarily learn the skills at home.

Yet 93% of teens believe they need financial knowledge and skills to achieve their life goals, and 97% of parents echo that sentiment, according to a March survey by Greenlight Financial Technology.

This is where something like a Roth IRA can be a great learning opportunity—from an investment and business ethic standpoint, the advisors said. “It teaches them about investing, the benefits of compounding, healthy investing habits, and it motivates them to act,” Barberis said.

Another benefit is the ability of parents, grandparents, family or friends to contribute the full amount, or part of it, on behalf of the child. This can help a child who is reluctant to give up some or all of their earnings, and also provide a financial boost for the future.

“She tells the kid, ‘Oh my God, this is really important because my parents don’t always want to give me money for everything, but they give me money for it,'” Colavita said.

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