Have a teenager working this summer?

Did they earn money babysitting or mowing lawns? 

How about a W-2 from selling ice cream or as a camp counselor?

You can open a Roth IRA for your child to evolve their financial knowledge while helping invest for retirement, a first house and/or qualified educational expenses.

Kids establishing Roth IRAs. There is no age minimum, as long as they earn income. It’s up to the parent to document to IRS that their kids had income earned from work, either W-2 or self-employment taxable wages.  

If under 18, an adult opens and maintains control of a Custodial Roth IRA with the child as beneficiary. Once an adult, usually 18 in most states, the account is transferred to a Roth IRA in their ownership.

After a Custodial Roth IRA is opened for 5 years, the advantages of tax-free earnings and withdrawals are same as Roth IRA. Recall a Roth IRA’s tax treatment is most valuable when time horizons are long and current tax rates are low, both true for kids.

What if your teen spent all their earnings? After a talk about budgeting (i.e. 3 Jars - Spend, Save, Gift), a parent or grandparent could fund a Roth IRA up to the amount of the child’s reported earned income on tax returns. 

Some parents will make ‘match’ contributions based on money earned in a summer job. If a teen earned $3,800 for 2024, a parent will fund $3,800.  

Remember, these contributions count against the $18,000 tax-free gifts per individual for 2024. So, if you’ve funded $18,000 for child’s 529 Plan, find another individual (i.e. spouse, relative) who can make the Roth IRA contribution. 

Introduction to personal investing. Have fun by letting your teen research an ETF or company to invest in, have them explain reasoning behind their choice and teach how they can follow. The next year, have them choose a different investment with the new contribution. Over time, they have a mix of investments, outcomes and lessons learned. This hands-on experience lays a foundation for making informed financial decisions of greater magnitude later in life.

Taxation of withdrawals before age 59 ½. A Roth IRA allows for 100% of contributions to be taken out for any reason, with no taxes or penalties. Furthermore, if a Roth IRA withdrawal is for qualified education expenses, you avoid the 10% penalty on earnings but still pay income tax on the earnings at the kid’s tax rate. Thus, Roth IRA could supplement educational savings. Later, they could also withdraw up to a $10,000 to pay for a first-time home purchase. 

Impact to financial aid? Yes, in a good way. The “expected family contribution” or “EFC” formula has student owned assets assessed at 20% with two notable exceptions. First is 529’s owned by parent’s is 5.6% and retirement accounts owned by parent or child counts as 0%. However, if a child takes money from a Roth IRA, even to pay for college, up to 50% of the withdrawal may be assessed.

In conclusion, opening a Roth IRA for kids is a proactive way for parents to teach financial responsibility and secure their children’s financial future. It’s not just about saving money; it’s about cultivating a mindset of financial discipline and planning that will benefit them throughout their lives. By harnessing the power of investing, compounding and leveraging tax advantages, parents can give their children a head start towards financial independence and security. 

Not all institutions offer Custodial Roth IRAs, but many do with no minimums and low fees. Consult your Certified Financial Planner to learn more.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Glenn Brown is a Holliston resident and owner of PlanDynamic, LLC, www.PlanDynamic.com. Glenn is a fee-only Certified Financial Planner™ helping motivated people take control of their planning and investing, so they can balance kids, aging parents and financial independence.

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