Every parent wants to ensure their children's success and happiness. Often we get parents who want to help their children save and build wealth. One strategy that’s often asked about is opening a Roth IRA in their name.
Let’s discuss the legal and tax requirements of this first, and then we’ll talk about some of the benefits.
Legal and tax requirements:
Your child must have legitimate income. This could be as simple as babysitting or mowing lawns. A lot of self-employed individuals feature their child in marketing material and pay them for that. Keep records of the tasks performed, hours worked, and wages paid. By providing your child with a legitimate role, you’ll meet the requirements for their Roth IRA contributions.
Consult with a tax professional to ensure compliance with tax laws. You may have to report their income and file a tax return for them.
Let's say your child satisfies the requirements for making Roth contributions, let’s talk about some of the benefits.
Capitalizing on the Power of Time:
The key advantage of starting a Roth IRA for your child is the power of compounding and time. By contributing to a Roth IRA early in their life, your child benefits from decades of potential growth. The earnings on their investments can compound over time, turning small contributions into a substantial nest egg by the time they retire.
Tax-Free Growth and Withdrawals:
One of the most attractive features of a Roth IRA is its tax benefits. All qualified withdrawals from a Roth IRA are entirely tax-free. This means that any growth your child's investments experience over the years won't be taxed when they withdraw the money in retirement. By taking advantage of their lower tax bracket during childhood and early adulthood, your child can maximize the benefits of tax-free growth.
A Roth IRA offers more flexibility compared to other retirement accounts. Contributions to a Roth IRA can be withdrawn penalty-free and tax-free at any time, making it a versatile investment vehicle. This flexibility can be advantageous if your child wants to pursue higher education, buy their first home, or address unexpected financial needs in the future.
Teaching Financial Responsibility:
Opening a Roth IRA in your child's name also provides a fantastic opportunity to teach them important financial lessons. Involve them in the process, explaining the concepts of saving, investing, and the power of compound interest. Encourage them to contribute a portion of their own earnings, such as money from part-time jobs or allowances. By engaging them in their financial future, you foster a sense of responsibility and provide valuable life skills.
The Roth IRA is a great way to give your kids a jumpstart on their own savings. If you have questions about eligibility, or aren’t sure where to start let me know and I’m happy to help.