I spoke with a client this week about funding a Roth IRA for their child. This is a great gift idea, as well as a sound financial strategy, so I thought I’d review it this week
I’ve written quite a bit about Roth IRAs versus traditional IRAs in the past. (you can find one such post here). Given the tax-free compounding of funds in a Roth IRA in perpetuity, the sooner you start investing in such an account, the better. As a result, they are exceptional options for children/young adults looking to save.
Few things to keep in mind if you are interested in helping your child fund a Roth IRA:
Annual limits – there are limits to how much you can put into a Roth IRA each year. These will apply to any Roth IRA account holder, including your child. For tax year 2023, that limit is $6,500 (plus catch-up contribution if over age 50)
Earned income – in addition to the annual limit, Roth contributions are further limited by the earned income of the account holder (ie: wages). With your child likely still in school or just starting their career, you will want to pay careful attention to their wages and limit contributions to that amount. As an example, if a child has a part-time job and earns $2,500 in a calendar year, the max they can put in is $2,500 (not the $6,500 max)
Any funds will do – While your child has to have wages/earned income to contribute to a Roth, there is no rule against you giving them the cash (or part of the cash) to fund it. Again, just keep in mind the dollar limitations, as well as the income tax gifting rules
Custodial options – if your child is a minor, they can still have a Roth IRA. You would just open it as a custodial account (with you or another trusted adult serving as custodian). They will gain full control of the account once they reach age of majority
As you can see, it’s relatively easy to use a Roth IRA for a child/young adult to start their saving and investing journey. This strategy hits close to home as this was how I got started too, with my parents helping me fund a Roth IRA as soon as I had wages. This approach has served me very well over time (thanks mom and dad!) and hopefully you will find is useful as well!