Diana Linn on Custodial Roth IRAs

Diana Linn:

How would you like to give your child the ultimate gift?

An enormous head start on retirement savings while teaching them the valuable lesson of how to save money. I’m referring to a custodial Roth IRA account.

Today, let’s explore the key aspects of using a custodial Roth IRA, why your children need one and how to set one up for their future wealth.

Hi, I’m Diana Linn, a wealth advisor with Today’s Adviser Takeaway.

If your children are anything like mine, it can be challenging to get them to save any amount of money, let alone considering establishing a retirement account. But the benefits of tax-free growth and flexible withdrawals might make this one of the greatest gifts you ever give your child.

Here are five important things to keep in mind about custodial Roth IRAs.

Number one, a custodial Roth IRA is an after-tax retirement account owned by a minor but controlled by an adult until that child reaches legal adulthood. Unlike a traditional IRA, there are no tax deductions for these contributions. However, since children are typically in the lowest tax bracket, the deduction is not really necessary.

Number two, Roth contributions can be withdrawn at any time for any reason without penalty. So this account could also serve as an education fund or an emergency savings account. One important thing to note though is that only the contributions themselves can be withdrawn at any time, not the earnings. Those can’t be touched until age 59 and half, with a few exceptions.

Third, there are no age restrictions to establish a custodial Roth account. However, your child must have earned income to contribute, so money earning from part time W-2 jobs, working within the family business, babysitting et cetera. If it’s reported to the IRS then it qualifies as earned income.

Fourth, the annual contribution limit for 2023 is $6,500, so you can contribute the lower of your child’s total earned income for the year up to $6500. So for example if my son earns $2000 this summer mowing lawns. I can contribute $2000 to a Roth account in his name, on his behalf.

And finally, the power is in compounding and the key here is to contribute to the Roth as much as you can, as early as you can. Allowing that money to grow, tax-free over a long period of time. A one time $6500 Roth contribution with no additional contributions could grow to over $235,000 in 60 years, assuming a 6% growth rate.

Now if you contributed the maximum, $6500, every year, starting at age 25, that would result in a Roth account with over $2 million in it. When your child turns 70, assuming a 7% growth rate.

And don’t worry, retirement accounts are not reported as assets on the FAFSA, so this will not affect their college financial aid.

If you have questions about Roth IRAs or how to establish one, we can help. Give us a call. And that’s Today’s Adviser Takeaway. Thanks so much for listening!