Starting a Roth IRA for Minors
How to Open a Retirement Account for Kids with Earned Income
May 13, 2009
Roth IRAs provide an attractive investment opportunity for individuals who are eligible to contribute to it. The major advantage of Roth IRA is that earnings grow tax-free and if the qualified distribution conditions are met, there are no taxes on withdrawals. By starting a Roth IRA early, the money will grow tax-free for many years.
There is no age limit for opening a Roth IRA, which means that a Roth IRA can be opened even for minors. The only requirement is that a minor needs to have earned (taxable) income to contribute to a Roth IRA. Many IRA providers allow starting minor accounts as long as the minor or his parent can provide proof that the minor earned it.
Advantages of Starting a Roth IRA for Minors
- The power of compounding- A Roth account started at a minor age will grow tax-free for fifty or more years, so even if only a small amount is invested each year, it will grow to a sizable amount by the time the minor retires.
- No taxes, ever- The amount that a teenager earns by doing his summer job or by assisting a parent in his/her business is usually too small to be taxed. This means that when he contributes the same amount to a Roth IRA he is not paying taxes and as the earnings grow tax-free, he doesn't have to pay taxes ever.
- A parent can make contributions on behalf of the child- IRS doesn't stipulate that the amount contributed must be the same amount that was earned by the child. Even if the child spends whatever he earns, a parent can contribute a matching amount.
- Saving for down payment of home- A Roth IRA is intended for retirement, but it can also be a great way to save for the down payment for purchasing the first-time home for the minor. A first-time home purchase is a qualified distribution which means that there is no 10% penalty for taking a distribution.
The only drawback for opening a Roth IRA in the name of a minor is that the ownership of the account passes on to the child when he attains maturity, so a parent will not be able to control how his son/daughter spends his/her account.
Earned Income
Many IRA providers allow opening minor accounts, but a parent needs to submit proof that the contributing amount was earned by the minor. The income has to be taxable compensation income and income from investments are not permitted.
- As long as the compensation is a reasonable amount for work actually performed, there is restriction for a child to accept payment for helping his/her parent's business.
- IRS do not specifically disbar a minor from contributing income earned by doing household chores, but as payments to family members for household chores are not taxable income, financial advisers do not recommend using them for contributions to IRAs.
- If a child earned income by doing odd jobs like baby sitting or mowing the lawn in the neighbourhood, it will still qualify as earned income if proper receipts and records are maintained.
Starting a Roth IRA at a young age can also be a good lesson on financial management and fiscal responsibility. In fact it can be one of the greatest gifts a parent or a grand parent can bestow on a child.
Source: Go Roth book by Kaye A. Thomas (Published by FAIRMARK PRESS INC, 2008)
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