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Can You Open a Roth IRA For Your Child?

January 20, 2021 · 5 minute read

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Can You Open a Roth IRA For Your Child?

A Roth IRA can be a great retirement investment tool for adults and children. Funded with after-tax dollars, a Roth IRA grows tax-free, so account holders won’t need to pay taxes when they withdraw money in retirement.

Like other individual retirement accounts, a Roth IRA has an early distribution penalty, but that penalty is waived for certain expenses, such as first-time home buying and paying for college. In this way, funding a Roth IRA can allow for more flexibility than a 529 college savings plan or other plan specifically earmarked for education.

That flexibility can make a Roth IRA appealing—especially if you’re a parent who wants to open a Roth IRA for your child. A Roth IRA for minors, called a Custodial Roth IRA, can be opened by any adult—whether a grandparent, parent, or family friend—for a minor who earns income (more on that later).

Here’s everything you need to know about making this investment.

Advantages of Opening a Roth IRA for Your Child

Flexibility in how to use the funds can be one benefit to opening a Custodial Roth IRA as part of an investment plan for your child. A Roth IRA can provide flexibility not only for potential expenses in early adulthood—such as going to college or buying a home—but can be an investment vehicle throughout your child’s lifetime.

Control Over Investments

Another benefit is that a Roth IRA gives you more control over investments than an education-focused 529 college savings plan, and can allow you to create a diversified portfolio made of bonds, stocks, ETFs, or whatever else you may want to add.

Compound Interest

A Roth IRA is a gift that can keep growing, since investors can maximize compound interest to get the most out of their investment.

Here’s how a Roth IRA unlocks the power of compounding: As an example, let’s say you open a Custodial Roth IRA when the child is 10 years old, and contribute $2,000 annually. At a certain point, your child might take over contributing $2,000 annually.

Assuming a 7% rate of return, the account will be worth $928,000 by the time your child is 60 years old—even though the total amount you and your child contributed would be $100,000 total. In comparison, if that same money was put in a taxable savings account over the same time period, the total of the account would be $515,764.

No Required Minimum Distribution (RMD)

Unlike a traditional IRA, there is no required minimum distribution (RMD) on a Roth IRA once the account owner reaches retirement age. A Roth IRA also allows people to continue contributing throughout their lifetime, as long as they’re earning income (with a traditional IRA, you can no longer contribute once you reach 70 ½).

Income Requirements for a Custodial Roth IRA

One reason it may not be immediately intuitive to open a Roth IRA for your child is that a Roth IRA account holder must earn income—but not too much income.

In order to qualify for a Roth IRA, an account holder (in this instance, the child) must make less than $140,000 annually. Individuals who make under $125,000 (filing as single taxpayers) can contribute up to $6,000 per year to a Roth IRA. Those who make between $125,000 and $140,000 are eligible to contribute a reduced amount.

Teens who have jobs “on the books”—lifeguarding, camp counselor—can contribute to a Roth IRA. But they can’t contribute more than their earned income for the year. For example, a teen who makes $2,000 per summer at their lifeguarding job can contribute no more than $2,000 to a Roth IRA.

Of course, this doesn’t mean that a teen has to invest all of their wages. In some cases, parents or grandparents might decide to contribute all or some of the maximum amount the teen is eligible for, and allow the account to grow this way.

Another way that parents can create a Custodial Roth IRA for their child is to hire their child on the books for household tasks that may include shoveling snow, babysitting, housework, or paperwork. Any earned income can then be put into the IRA. If the income comes from self-employment, it makes sense to discuss details with a tax professional, in case any Medicare or Social Security taxes need to be paid.

If you have a business and are hiring your child to do work for your business, make sure their work is business-related (for example, cleaning the office or stuffing envelopes is likely fine; raking leaves may not be unless it is a legitimate business expense).

The IRS also pays attention to the age of your child. Tweens and teens can perform work, but infants and toddlers are likely not doing any work for your business unless there is a legitimate business need for them (such as a clothing designer using an infant to model clothing as marketing material).

How to Open a Roth IRA For Your Child

A Custodial Roth IRA for a minor can be opened by any adult—whether grandparent, parent, or family friend. While the child is a minor, the adult will have sole access to the account; once the child comes of age (the timing of which varies by state), the account will transfer over to the child.

As with any Roth IRA, investment options within the account can include stocks, bonds, ETFs, and mutual funds.

A Roth IRA can be opened with an investment broker or brokerage firm. Some brokerages may have an automated method that can allow the account owner to be relatively hands off with the account once they input goals and risk tolerance, others may require the account owner to direct the account, choosing investments. Choosing the right brokerage and account depends on the investor and their preferences.

Who Can Contribute to a Custodial Roth IRA for Your Child?

Unlike a 529, which anyone can contribute to, only the custodian of the Roth IRA account can contribute funds into the account. But it’s important to be mindful of how much your child has earned during the year and only contribute up to that limit.

For example, if a child has a lifeguarding job that earns her $2,000 a year, only $2000 may be contributed to the Custodial Roth IRA that year—regardless of whether the child contributes the money themselves, or whether the parents contribute their own money to the account and allow the teen to use the money she earned as she sees fit.

Some parents create an arrangement with their child where the minor contributes a certain percentage of their income (and keeps the rest), and the parents make up the difference in contributions.

How a Roth IRA Can Help Your Child Understand Investing

Not only can a Custodial Roth IRA unlock the power of compound interest and grow contributions substantially more than a typical savings account, but they can also be a powerful tool to help a child understand investing and how compound interest works.

While some custodians may contribute the equivalent of their child’s income and let their child use their earned income for their own discretionary spending, others might encourage their child to actively earmark a certain portion of their earnings for their Roth IRA account. Either way, custodians can share the account status with their child, explaining their portfolio, showing gains, and otherwise making the investment feel more active to their child.

There’s no “wrong” way to manage a Roth IRA with your child, but letting your child peek into their account can help them ask questions about personal finance and grasp investing well before they have to make their own retirement saving decisions. This can help your child have a grasp on financial fluency that can be helpful when they reach the age where they can manage their accounts themselves.

The Takeaway

For a child with an income, Opening a Roth IRA for a child with an income can be a good way to start them on the path to investing—whether it’s saving for retirement, education, a first home, or more.

When it comes to making an investment strategy for kids, it can also be a good time for parents to audit overall retirement strategies. In some cases, it may make sense for parents to make sure their own retirement strategies are on track before opening a Roth IRA for their children.

SoFi Invest® offers both active and automated IRA options as part of their investing plans for retirement. Find out how SoFi can help you reach your retirement goals.


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