Can kids use a Roth IRA? Yes!
Cash Flow and Retirement
If you’re looking for ways to teach your kids about financial planning and want to give them a head start on building a retirement nest egg, take a look at Roth IRAs. Contributions to a Roth IRA can’t exceed an individual’s earned income, so your child must have some earnings from an after-school or summer job. But, subject to that limit, anyone can contribute to a Roth IRA on the child’s behalf.
Contributions and Withdrawls
Here’s why Roth IRAs work so well for kids. Although contributions aren’t tax deductible, qualified withdrawals are tax-free. This makes Roth IRAs advantageous for people who will likely be in a higher tax bracket when they’re ready to withdraw funds. Most kids are in the lowest tax bracket, which
means tax deductions aren’t worth much to them. But the benefits of tax-free withdrawals, when their income is likely to be much higher, are significant.
Contributions to a Roth IRA can be withdrawn tax- and penalty-free at any time. Earnings withdrawn before age 59½ generally are subject to a 10% penalty. Because kids have many decades before they will reach retirement age, the power of compounding can help them generate meaningful savings even with relatively modest, but early, contributions.
To take an example, Emma is 12 years old and earns $1,200 per year babysitting. Her parents set up a Roth IRA for her and contribute $100 per month over the next 10 years. Even if Emma never makes another contribution to the Roth IRA, by the time she turns 62 the account will have grown to more than $250,000 (assuming a 7% rate of return).
Roth IRAs can give kids a big head start on retirement saving, but they also offer flexibility. For example, because contributions can be withdrawn any time without penalty, your children can use their accounts to help pay college tuition, buy a house or even start a business.