Can I Open A Roth IRA For My Child?
Parents always want their children to succeed financially so they do everything they can to set them up for a good future. One of the options for parents is to set up a Roth IRA and we have a lot of parents that ask us if they are allowed to establish one on behalf of their son or daughter. You can, as long as they have earned income. This can be a
Parents will often ask us: “What type of account can I setup for my kids that will help them to get a head start financially in life"?”. One of the most powerful wealth building tools that you can setup for your children is a Roth IRA because all of accumulation between now and when they withdrawal it in retirement will be all tax free. If your child has $10,000 in their Roth IRA today, assuming they never make another deposit to the account, and it earns 8% per year, 40 years from now the account balance would be $217,000.
Contribution Limits
The maximum contribution that an individual under that age of 50 can make to a Roth IRA in 2022 is the LESSER of:
$6,000
100% of earned income
For most children between the age of 15 and 21, their Roth IRA contributions tend to be capped by the amount of their earned income. The most common sources of earned income for young adults within this age range are:
Part-time employment
Summer jobs
Paid internships
Wages from parent owned company
If they add up all of their W-2's at the end of the year and they total $3,000, the maximum contribution that you can make to their Roth IRA for that tax year is $3,000.
Roth IRA's for Minors
If you child is under the age of 18, you can still establish a Roth IRA for them. However, it will be considered a "custodial IRA". Since minors cannot enter into contracts, you as the parent serve as the custodian to their account. You will need to sign all of the forms to setup the account and select the investment allocation for the IRA. It's important to understand that even though you are listed as a custodian on the account, all contributions made to the account belong 100% to the child. Once the child turns age 18, they have full control over the account.
Age 18+
If the child is age 18 or older, they will be required to sign the forms to setup the Roth IRA and it's usually a good opportunity to introduce them to the investing world. We encourage our clients to bring their children to the meeting to establish the account so they can learn about investing, stocks, bonds, the benefits of compounded interest, and the stock market in general. It's a great learning experience.
Contribution Deadline & Tax Filing
The deadline to make a Roth IRA contribution is April 15th following the end of the calendar year. We often get the question: "Does my child need to file a tax return to make a Roth IRA contribution?" The answer is "no". If their taxable income is below the threshold that would otherwise require them to file a tax return, they are not required to file a tax return just because a Roth IRA was funded in their name.
Distribution Options
While many of parents establish Roth IRA’s for their children to give them a head start on saving for retirement, these accounts can be used to support other financial goals as well. Roth contributions are made with after tax dollars. The main benefit of having a Roth IRA is if withdrawals are made after the account has been established for 5 years and the IRA owner has obtained age 59½, there is no tax paid on the investment earnings distributed from the account.
If you distribute the investment earnings from a Roth IRA before reaching age 59½, the account owner has to pay income tax and a 10% early withdrawal penalty on the amount distributed. However, income taxes and penalties only apply to the “earnings” portion of the account. The contributions, since they were made with after tax dollar, can be withdrawal from the Roth IRA at any time without having to pay income taxes or penalties.
Example: I deposit $5,000 to my daughters Roth IRA and four years from now the account balance is $9,000. My daughter wants to buy a house but is having trouble coming up with the money for the down payment. She can withdrawal $5,000 out of her Roth IRA without having to pay taxes or penalties since that amount represents the after tax contributions that were made to the account. The $4,000 that represents the earnings portion of the account can remain in the account and continue to accumulate tax-free. Not only did I provide my daughter with a head start on her retirement savings but I was also able to help her with the purchase of her first house.
We have seen clients use this flexible withdrawal strategy to help their children pay for their wedding, pay for college, pay off student loans, and to purchase their first house.
Not Limited To Just Your Children
This wealth accumulate strategy is not limited to just your children. We have had grandparents fund Roth IRA's for their grandchildren and aunts fund Roth IRA's for their nephews. They do not have to be listed as a dependent on your tax return to establish a custodial IRA. If you are funded a Roth IRA for a minor or a college student that is not your child, you may have to obtain the total amount of wages on their W-2 form from their parents or the student because the contribution could be capped based on what they made for the year.
Business Owners
Sometime we see business owners put their kids on payroll for the sole purpose of providing them with enough income to make the $6,000 contribution to their Roth IRA. Also, the child is usually in a lower tax bracket than their parents, so the wages earned by the child are typically taxed at a lower tax rate. A special note with this strategy, you have to be able to justify the wages being paid to your kids if the IRS or DOL comes knocking at your door.
About Michael.........
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
How Do Inherited IRA's Work For Non-Spouse Beneficiaries?
The SECURE Act was signed into law on December 19, 2019 which completely changed the distribution options that are available to non-spouse beneficiaries. One of the major changes was the elimination of the “stretch provision” which previously allowed non-spouse beneficiaries to rollover the balance into their own inherited IRA and then take small
The SECURE Act was signed into law on December 19, 2019 which completely changed the distribution options that are available to non-spouse beneficiaries. One of the major changes was the elimination of the “stretch provision” which previously allowed non-spouse beneficiaries to rollover the balance into their own inherited IRA and then take small required minimum distributions over their lifetime.
That popular option was replaced with the new 10 Year Rule which will apply to most non-spouse beneficiaries that inherit IRA’s and other types of retirements account after December 31, 2019.
New Rules For Non-Spouse Beneficiaries Years 2020+
The article and Youtube video listed below will provide you with information on:
New distribution options available to non-spouse beneficiaries
The new 10 Year Rule
Beneficiaries that are grandfathered in under the old rules
SECURE Act changes
Old rules vs New rules
New tax strategies for non-spouse beneficiaries
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
How To Teach Your Kids About Investing
As kids enter their teenage years, as a parent, you begin to teach them more advanced life lessons that they will hopefully carry with them into adulthood. One of the life lessons that many parents teach their children early on is the value of saving money. By their teenage years many children have built up a small savings account from birthday gifts,
As kids enter their teenage years, as a parent, you begin to teach them more advanced life lessons that they will hopefully carry with them into adulthood. One of the life lessons that many parents teach their children early on is the value of saving money. By their teenage years many children have built up a small savings account from birthday gifts, holidays, and their part-time jobs. As parents you have most likely realized the benefit of compounding interest through working with a financial advisor, contributing to a 401(k) plan, or depositing money to a college savings account. As financial planners, we often get the question: “What is the best way to teach your children about the value of investing and compounding interest? "
The #1 rule.......
We have been down this road many times with our clients and their children. Here is the number one rule: Make it an engaging experience for your kids. Investments can be a very dull topic to talk about and it can be painfully dull from a child’s point of view. All they know is the $1,000 that was in their savings account is now with their parent’s investment guy.
Ignoring the life lessons for a moment, the primary investment vehicle for brokerage accounts with balances under $50,000 is typically a mutual fund. But let’s pause for a moment. We have a dual objective here. We of course want our children to make as much money as possible in their investment account but we also want to simultaneously teach them life long lessons about investing.
The issue with young investors
Explaining how a mutual fund operates can be a complex concept for a first time investor because you have all of these companies in one investment, expense ratios, different types of funds, and different fund families. It’s not exciting, it’s intimidating.
Consider this approach. Ask the child what their hobbies are? Do they have a cell phone? Have them take their cell phone out during the meeting and ask them how often they use it during the day and how many of their friends have cell phones. Then ask them, if you received $20 every time someone in this area bought a cell phone would you have a lot of money? Then explain that this scenario is very similar to owning stock in a cell phone company. The more they sell the more money the company makes. As a “shareholder” you own a piece of that company and you receive a piece of the profits if the company grows. If your child plays sports, do they wear a lot of Nike or Under Armour? Explain investing to them in a way that they can relate it to their everyday life. Now you have their attention because you attached the investment idea to something they love.
A word of caution....
If they are investing in stocks it is also important for them to understand the concept of risk. Not every investment goes up and you could start with $1,000 and end the year with $500, so they need to understand risk and time horizon.
While it’s not prudent in most scenarios to invest 100% of a portfolio in one stock, there may be some middle ground. Instead of investing their entire $1,000 in a mutual fund, consider investing $500 – $700 in a mutual fund but let them pick one to three stocks to hold in the account. It may make sense to have them review those stock picks with your investment advisor for two reasons. One, you want them to have a good experience out of the gates and that investment advisor can provide them with their option of their stock picks. Second, the investment advisor can tell them more about the companies that they have selected to further engage them.
Don't forget the last step......
Download an app on their smartphone so they can track the investments that they selected. You may be surprise how often they check the performance of their stock holdings and how they begin to pay attention to news and articles applicable to the companies that they own.At that point you have engaged them and as they hopefully see their investment holdings appreciate in value they will become even more excited about saving money in their investment account and making their next stock pick. In addition, they also learn valuable investment lessons early on like when one of their stocks loses value. How do they decide whether to sell it or continue to hold it? It’s a great system that teaches them about investing, decision making, risk, and the value of compounding investment returns.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
