This article is within the framework of the Roth IRA Account Movement, a widespread campaign in the personal finance blogging community today.
One valuable gift you can give to your child is the skill of financial intelligence, including the importance of saving for their future. These invaluable lessons remain useful, even if they choose a more extravagant lifestyle later in life. A practical method of instilling the savings habit early on can be by opening a Roth IRA for them.
Eligibility Criteria For Opening a Roth IRA
A young individual with an earned income can contribute to a Roth IRA. The contribution could be their total annual earnings or the $5,000 maximum yearly Roth IRA limit, depending whichever is less. In order to verify income, there should be issued W-2s or meticulously maintained records of pay and job details. If income is in cash, a tax return based on documented earnings must be filed as a proof of income.
Please be aware that not all investment firms provide Roth IRAs for children, but you can find some that do, like Schwab, which only requires a minimum of $100 to open. Certain investment firms may necessitate a parent as the account custodian until the child reaches legal age.
Tax Benefits
If your child earns from $100 up to several thousand dollars a year, they would fall into a low tax bracket. By putting the taxed money into a Roth IRA at this stage, it grows and can be withdrawn tax-free post 59.5 years of age.
Advantages
Compounding Interest: If, for example, your 14-year-old begins earning some money and investing it in a Roth IRA, they have over 46 years for the funds to multiply due to compounding interest.
Flexible Withdrawals: Your child can withdraw the invested principal (without touching the earned interest) for education costs or for a house down payment without any penalty.
Consider matching your child’s contribution if they’re hesitant to invest their entire earnings into a Roth IRA. For instance, if they earn $1,500 in one year, suggest they contribute $750 for Roth IRA, and you can contribute the other half. This way, the total investment of $1,500 is still made, while leaving them $750 for other expenditures.
Even if your child deposits a few thousand dollars during their teenage years, that amount can grow significantly. For instance, if a 16-year-old invests his $5,000 income in a Roth IRA once and never invests again, this can grow to an impressive $217,137 by the time he is 65 (assuming an 8% annual return). This potential could be even greater with further regular contributions.
Drawback
When your child applies for financial aid, his Roth IRA could be seen as an asset and included in his financial aid need calculation. Therefore, consulting a professional on this subject is advisable prior to opening a Roth IRA.
All said, getting a child to invest in a retirement account might be challenging, but the benefits far outweigh the effort. Personally, we plan to open a Roth IRA for our son as soon as he starts earning.
