If your child earns taxable income, he can begin socking money away right now — tax-free — in a custodial Roth IRA. Custodial accounts are managed by a parent or guardian on behalf of a minor child. The Roth IRA's tax benefits make it an attractive investment option for parents of working-age children. Open the account while your kid is a teenager, and he could end up with an impressive nest egg by the time he retires.
Creating the Account
There is no minimum age requirement to open a Roth IRA, but your child must be working, and the pay has to be taxable. Because minors can't enter into contracts, a parent or guardian must create the account. Different banks offer various deals and incentives, so shop around for a bargain. Initial contribution amounts range from $500 to $3,000, but some investment companies waive the setup fee if you sign up for other services or agree to contribute a regular monthly amount.
You may be the custodian of your child's account, but the money is his. IRS rules prevent the parent from moving the money to other accounts. When your child reaches the age of majority — 18 in most states — the custodial Roth IRA becomes his property. The money is his, free and clear, to spend however he wishes. If you worry about your newly liberated teenager blowing his retirement savings on spring break, speak to an investment advisor about other options.
Your child is allowed to put up to $5,000 in his Roth IRA each year. You can sweeten the deal by offering to let him spend a portion of his earnings elsewhere while you pitch in enough to cover his expenditures. He has to actually earn the money, though. For example, if he brings home $5,000 from a landscaping job, he can contribute $2,500 to his IRA and spend the other half on a new computer. You are permitted to deposit a max of $2,500 into the IRA because he actually earned $5,000 total.
Bagging groceries or flipping burgers might not seem that lucrative now, but a little goes a long way — especially when you add up a lifetime's worth of yearly deposits. Annual contributions can be withdrawn tax-free and for any purpose, including college costs, at any time. Earnings can be taken out without penalty after age 59½. As a bonus, if your child waits until retirement age to tap into his Roth IRA, he will likely be in a much lower tax bracket than someone of working age.
A.M. Hill has been a licensed attorney since 2004. Her practice areas include family law and divorce, probate and estate planning and bankruptcy. Hill holds a Juris Doctor from the Cleveland-Marshall College of Law.