Parents often wonder whether it makes sense to open an IRA for a young child. In most cases, it’s a good idea and can help a youngster learn about handling money and save for retirement at the same time. And in most every situation when you want one for a child, you should opt for the Roth rather than a traditional. That’s because Roth have fewer restrictions on withdrawals. That means the child can take the contributed money, not the interest, out at any time and for any reason. The contributions can be used for buying a car or paying college tuition, for example, with no penalty on the withdrawal.
If you’re considering opening an IRA for your child, there are a few things to understand before signing the papers and placing those first few dollars into the account.
Open a Custodial Roth
For account holders under the age of 18, you’ll need to open the account for them as a custodian. That means you manage the account until the child’s 18th birthday. You can usually open a custodial Roth IRA though a major bank or brokerage firm where you already do business. Be ready to have Social Security numbers for both yourself and the child, along with standard ID for yourself and proof of the child’s birthday. The process is relatively simple and tends to take less than 20 minutes if you have all your paperwork in order. It’s also possible to make an initial deposit at the time of opening the account, so be sure to have funds ready to go too.
The Child Must Have Earned Income
Here’s the big catch on IRAs for children: The only contributions that can be made are those that do not exceed the child’s earned income for the year. Don’t think you can open the IRA in your child’s name and plunk $10,000 into it as an initial deposit. The only amount that can go into a custodial IRA is an amount equal to or less than the child’s earned income. Keep track, on paper, of any money your child earns from jobs like baby-sitting, washing cars, selling lemonade, mowing lawns, or similar efforts. You’ll also want to be certain to obtain W-2 statements for any income the child earns from a regular full-time summer job or part-time job during school months.
You Can Make All or Part of the Contribution for Your Child
It’s your option, as the account custodian, to make all, part or none of the allowed contribution to your child’s IRA, remembering that the maximum is the same as for “adult” Roth IRAs: $6,000. For example, if your daughter earns $700 from baby-sitting on weekends during the school year and earn another $3,600 during a summer job at the local pizza restaurant, she can contribute up to $4,300 to her IRA that year. But what if she spends all the money when buying a used car? You, as the loving parent, can legally make the contribution for her, as long as you don’t exceed the $4,300 limit that is based on her “earned income.”