Kids can’t have a ROTH IRA, right? Think again!

My wife and I were mentoring two teenagers at our house one evening. One of the teens grandmother came to us to see if we would sit down one evening and talk to them about savings. I was ecstatic! For over an hour we talked about savings, budgeting, and planning for the future. One of the teens (about 18 at the time) was working with a family member doing construction like 3 or 4 days a week. He was making a decent amount of money for a teen, and he was having problems saving it because he was spending too much. Although this post is not about spending, or even about savings, these ideas are connected to a Roth IRA.

The irony of all, is that while grandma was listening to us ‘talk’ finances with the two teens, she started asking us questions about retirement, paying debt, and even budgeting. After our ‘session’ was over, the 2 teens were thrilled about their financial knowledge, and so was grandma.

A few weeks later we got together again with them and asked how the budgeting and saving was going. More importantly I asked if they had opened a Roth IRA yet. One of the teens (she was 17 at the time) told me, that they did not open a Roth IRA, because when they got home the first night we got together, she asked her mom to help her and mom told her that they could only have a Roth IRA if their employer ‘offers it’ to them as a benefit.

My wife and I learned a powerful lesson that night. In fact, this blog was in part inspired to a degree from that lesson. We understood that night that teens and young adults need better financial education. Worse yet, a lot of parents need better financial education! Numbers today suggests that people are more in need of solid financial education than ever before.

On this post, I wanted to target specifically the KID’s Roth IRA myth. Although Roth IRA are not for everyone. In fact, if you are a family that makes more than $180,000 a year, you need to consider other options like a Roth 401K or a regular 401K for tax purposes. The truth is that most families can and should have a Roth IRA now. I always recommend parents to start a Roth IRA for their kids as early as possible. Yes!! Kids can have a Roth IRA without their ‘employers offering it’!

So, if you are a parent of a little one or a teen working, and you want to give them financial freedom, here are the three steps to get it done once and for all:

First, in order for your kid to be able to have a Roth IRA they must earned income during that tax year. If your kid cuts the neighbor’s grass, have a lemonade stand, or babysits once a week, that income can be contributed to a Roth IRA. They can contribute as much as they earn, up to the account limits per tax year (currently $5,500.00 per child). This is the most important eligibility requirement, earned income, but if you can prove they earned it, they can make it grow. Warning: it can’t be an allowance, or a gift! However, parents (or other family members) can contribute cash gift to the account, but some IRS rules and tax penalties may apply. Check the IRS website to find out the exact definitions of income and how to keep track of it here.

Second, you can contact several free financial institutions that offer a Roth IRA for kids and set up an account yourself with little paperwork and in less than 15 minutes! Some places call these IRA accounts ‘custodial accounts’ and they can be open by a parent or a grandparent (the custodian) for a child (under 18 years of age). When the account is open under the child’s name, the money has more time to grow (and earn compound interest) and can give your child a great head-start to save for college, a first home, or even retirement. For example, if you do a onetime deposit of $1,000.00 into the account when the kid is 10 years of age, and they never contribute anything else, by age 67 (with a 10% return a year) the child will have over $200,000.00. Here is a list of a few institutions that offer Roth IRA for kids and adults: Fidelity, Charles Schwab, principal financial, E-trade, and Merrill Edge Financial, among others. Take time to compare them and to ask if they have sign in bonuses.

Third, when the account is up and running only the adult (or custodian) can make the decisions about how the money is invested or used. There are several ways that you can allocate the money but the 2 most common ones are: 1- you can design a ‘custom made’ portfolio yourself (if you are a savvy investor) or 2- you can have a ‘premade fund’ (like mutual funds) that adjust automatically and allocates the money as you child grows (recommended for most people). There are some fees associated with these accounts, usually a transaction fee that ranges from $7.00 to $10.00 per transaction depending on the institution. My recommendation to you is to try to save money by doing as little transactions as you can per tax year, and that money will grow exponentially.

Finally, the money can be withdrawn and used for a variety of things like buying a first home (no time penalty), retirement (usually at age 59-1/2), and college (after 5 years of opening the account) tax free! However, check with your institution’s advisor to get more details about withdrawing the money to avoid tax penalties. There you have it! three simple steps to open a kids Roth IRA that can help them save money and be financially free earlier in life. Don’t waste any time, your kid’s future depends on it. Enjoy!

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4 thoughts on “Kids can’t have a ROTH IRA, right? Think again!”

  1. I set up a ROTH IRA for my niece who just graduated from college. It’s a managed account, which means she can contribute, but I’m in charge of the account. My hope is that after a few years, she will see her money grow and continue to save for her retirement. Starting while she’s a teenager will give her a HUGE advantage as she gets older.

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