Why Your Kids Need a Roth IRA—The Ideal Savings Vehicle for Young People

How a Roth IRA for kids works

Yes, children are eligible to have their own Roth IRA, and the IRS rules governing these accounts are similar to those for adults.

For 2024, individuals under age 50 can contribute up to $7,000 to any IRA account—whether Roth, traditional, or a combination of the two. However, contributions are limited to the amount of earned income the individual has for the year. If a child earns less than $7,000, they can only contribute up to their total earned income, as contributions cannot be made using gift money.

Although a child must have earned income to qualify for Roth IRA contributions, the actual funds used to contribute can come from someone else. This allows the child to retain their earnings for immediate expenses, while the Roth IRA is funded separately, helping to establish a solid financial foundation without using their own money.

Parents, grandparents, or any generous relative or benefactor can set up and contribute to a Roth IRA on behalf of the child.

There is no minimum age requirement to contribute to a Roth IRA—as long as a child has earned income, they are eligible to have one.

However, if the child is a minor (under age 18 in most states or under age 21 in some), a parent or guardian must open a custodial Roth IRA on the child’s behalf and manage the investments until the child reaches the age of majority. While the custodian controls the account, the child is the beneficial owner, meaning the funds must ultimately be used for their benefit.

Regarding the income requirements for a Roth IRA, the child must have earned income to contribute. This income can come from traditional employment, such as a part-time job, or from self-employment activities like babysitting or lawn mowing. However, money received from parents for chores, allowances, or cash gifts does not qualify as earned income and cannot be used for Roth IRA contributions.

Most children, particularly younger ones, are unlikely to reach the $7,000 maximum annual contribution limit for 2024. Instead, their contributions are capped at the total amount of earned income they generate during the year.

Even if the child is not required to file an income tax return, the parent or custodian must maintain accurate records of the earnings used for Roth IRA contributions. Self-employment income may also be subject to additional taxes, such as Medicare and Social Security. Consulting a tax professional is recommended to ensure compliance with tax regulations and to maximize potential benefits.

Why I Favor the Roth IRA for Young People

I consider the Roth IRA to be an ideal savings vehicle for young people because it not only offers tax-sheltered growth but also provides a degree of liquidity.

While the Roth IRA is intended as a long-term savings tool, it offers flexibility. In the event of an emergency, young account holders—who have many years before retirement—can access their contributions without penalties or significant drawbacks, making it both a practical and strategic option for young savers.

Opening a Roth IRA for young individuals is an effective way to help secure their financial future. By starting early, they can maximize the benefits of tax-free growth, potentially accumulating a substantial retirement fund by the time they reach retirement age.

There are additional benefits to a Roth IRA. Since contributions are made with after-tax dollars, withdrawals during retirement can be tax-free, as long as specific conditions are met. This is especially beneficial for children, who are likely in a low or zero tax bracket now, enabling them to grow their investments over time without the burden of taxes.

Starting a Roth IRA early enables the account to benefit from decades of compound interest, significantly increasing its value over time. For example, if a 15-year-old contributes $2,000 annually until age 65, with an average annual return of 7%, the account could grow to nearly $1 million by retirement.

Unlike traditional IRAs, Roth IRA contributions can be withdrawn at any time without incurring penalties or taxes. Additionally, under certain conditions, such as a first-time home purchase, even the earnings on those contributions may be withdrawn penalty-free.

Another advantage of Roth IRAs, compared to traditional IRAs, is that they do not require mandatory withdrawals at a specific age. This allows the account to grow tax-free for as long as the owner desires, giving young individuals greater flexibility and control over their retirement funds, which can be beneficial when managing their retirement income.

Starting a Roth IRA can also serve as a valuable educational tool, helping young individuals learn about investing, saving, and financial planning early on. The structure of a Roth IRA promotes a long-term financial perspective, fostering habits that contribute to building a secure financial future.

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