Open A Roth IRA For Your Child

by | | Investing, Other Cool Stuff, Retirement, Taxes

Open a Roth IRA for your child as soon as she has her first job. Give her decades of tax-free growth, and teach her about money in the process.

Why You Should Open A Roth IRA For Your Child

Tax-Free Growth

A Roth IRA is not taxed while it grows, and withdrawals in retirement are tax-free. Because your child is starting so young, the Roth IRA is an especially powerful wealth-building tool.

Say your child earns $2,500 per summer for four years of high school. She contributes $1,250 per summer to her Roth IRA, and you match another $1,250 per summer.

Assuming a 7% rate of return, her Roth IRA will be almost $2.4 million tax-free at her age 60!

That’s in future dollars, but assuming 3% inflation, it’s still a cool $634K tax-free in today’s buying power.  Not bad for a high school summer job!

Teach About Money

By involving your child in this process, you can teach her valuable lessons about money. Have her contribute so she has skin in the game. Match her contributions to provide incentive. Show her how much the account could grow to if she leaves it alone.

How To Open A Roth IRA For Your Child

Which Company To Use

Many investment custodians allow you to open a Roth IRA for a minor. Some well-known examples are Charles Schwab, Fidelity, and Vanguard. If you’re working with a financial advisor, he or she will do this for you. We do this for our clients.

Your child is the account owner, and you are the custodian. Your child gains control of the account at your state’s age of majority (usually 18 or 21). Encourage her to keep contributing each year she has earned income.

How Much To Contribute

Your child’s maximum contribution is the lesser of earned income or $6K (2022).

  • Earn $2K: max is $2K.
  • Earn $8K: max is capped at $6K.

Contributions are due by the tax filing deadline. This is usually April 15, but can change due to a weekend or holiday.

You and your child can both contribute to her Roth IRA. In the example above, she earned $2,500 and you each contributed $1,250. The only requirement is that you don’t exceed the max contribution.

After she reaches the age of majority, you can still contribute to her Roth IRA. For example, you could continue matching her contributions until she graduates from college.

What To Invest In

Invest the money in a low-cost fund that is 100% in the stock market. Stocks are risky, which is why they have a high expected return over the long term. Your child has a lifetime to wait out the stock market’s ups and downs in pursuit of long-term growth.

For our clients’ children, we use DFA Global Equity (DGEIX). Another good option is Vanguard Total World Stock Index (VTWAX or VT).

We like these funds because they cover the entire world stock market, not just the United States. This provides more diversification. Lately, U.S. stocks have outperformed international stocks, but sometimes it will be the other way around, and nobody can predict this in advance.

Real-World Logistics

You need to know your child’s exact earned income to determine her max Roth IRA contribution. Exact earned income is in box 1 of Form W-2 (wages, tips, other compensation). W-2s must be issued by the end of January.

So, wait until your child’s W-2 arrives. Her max contribution is the lesser of box 1, or $6K (2022). Then make the contribution by the tax filing deadline.

If your child has earnings that aren’t reported on a W-2 (like lawn mowing or babysitting), see Roth IRA For Your Child With Cash Income.

If you’d like to open a Roth IRA for your child, but you’re too busy to make it happen, schedule a FREE Financial Pulse Assessment™. This is a 3-step process to get clarity on your finances and “test drive” our services.

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