IRA For Your Child: Why It’s a No Brainer

7 minute read

The last thing on your mind is probably opening a retirement account for your child. Many taxpayers don’t know that setting up an individual retirement account (IRA) for a child is even a possibility. However, it’s a great way to give your child a head start on a savings plan so they have money set aside for the future. Opening a Roth IRA gives your child a leg up on a retirement plan and teaches them responsible money habits at a young age. Whether you contribute pre-tax dollars to a traditional IRA or after-tax dollars to a Roth IRA, your money grows tax-free.

Why Should You Set Up an IRA for a Child?

Setting up a Roth IRA for a child may sound a little foreign at first, but it’s a good choice for a child with a limited income. This is because a Roth IRA sets the child up to enjoy tax-free income during retirement and before if needed. Notably, a Roth IRA allows your child to withdraw money tax-free and penalty-free after age 59 ½; with traditional IRAs, withdrawals are taxed as current income after age 59 ½.

Since there are no age restrictions, a Roth IRA is ideal for children because they will have decades of contributions, interest, and dividends adding up throughout the years tax-free. This also sets a good example at a young age for nurturing healthy financial habits and ensuring financial security for the future.

Setting up an IRA for a child is a great strategy for parents and children. This is especially relevant for parents who run their own businesses. If they hire their child as a legitimate employee they can deduct the child’s wages from the business’ income as an expense and the child can put away money for retirement; it is a win-win situation.

In most instances, if the child is under 18, the parent doesn’t have to withhold or pay social security or medicare tax on the child’s wages. This allows the parent to shift some of their business income over to the child’s bracket and benefit from a lower tax rate. Each of these benefits can result in a substantial amount of tax savings.

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What Are the Stipulations for Starting an IRA for a Child?

The one stipulation for opening a Roth IRA for a child is that the child, who can be at any age, must have earned income to contribute to the account. Not only can the child contribute, but anyone can contribute on behalf of the child.

The IRS considers income from an after-school or summer job as earned income. For the income to be eligible when there is not a 1099 form, the work should be considered age-appropriate and the income should be considered reasonable wages.

How to Open an IRA for a Child

Opening a Roth IRA for your child is a simple process. A child’s Roth IRA has to be set up as a custodial account by a parent or another adult. There are many financial firms that offer custodial Roth accounts for children. Some of the more well known firms include E*Trade, Fidelity, TD Ameritrade, and Schwab.

The custodian of a Roth IRA account makes all of the investment decisions and controls the funds until the child reaches the majority age for their state, which is usually 18, 19, or 21. At that point, the IRA transfers to the child’s name only.

The process itself just involves filling out paperwork with the parent and child’s social security numbers, dates of birth, and other personal information.

Can I Contribute to an IRA For My Child?

Once the Roth IRA account owner is over 59 ½, withdrawals made from the account are 100% tax-free. Even if money is withdrawn sooner, the withdrawals are tax and penalty-free if they have had the account for five years or more.

Parents or anyone else can make contributions as well. The only stipulation is that all of the contributions combined can not exceed the child’s income for the given tax year. There is also a maximum contribution limit of $6,000 to a Roth IRA account for the year 2022.

Getting the Most Out of a Roth IRA for a Child

Corvee tax planning software can help you find ways to benefit the most from the funding of retirement accounts. Corvee also considers over 1,700 other tax planning strategies you may qualify for. There are many more ways to reduce your taxes. Corvee helps uncover more tax savings. Request a demo today.

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