How to Set Up and Manage a Roth IRA for Your Child

Establishing a Roth IRA for your child can be a strategic move to secure their financial future, offering the potential for tax-free growth over many years. This long-term investment tool is not just for adults; minors with earned income are eligible too, making it an appealing option for parents to give their children a head start in wealth accumulation.

Setting Up an Account for a Minor

To set up a Roth IRA for a minor, choose a custodial account, as minors cannot legally own financial accounts. A custodian, typically a parent or guardian, manages the account until the child reaches the age of majority, generally 18 or 21, depending on the state. Financial institutions like Vanguard, Fidelity, and Charles Schwab offer custodial Roth IRAs with varying fees and investment options. Comparing these offerings ensures alignment with your child’s financial goals.

After selecting a custodial account, gather the required documentation, such as the minor’s Social Security number and proof of earned income. Contributions to a Roth IRA must come from earned income, which can include wages from part-time jobs or self-employment income like babysitting or lawn mowing. Keeping detailed records of this income is essential, as the IRS may request verification.

Verification of Earned Income

The IRS requires that Roth IRA contributions come exclusively from earned income, such as wages, salaries, or tips. For minors, this often means income from part-time jobs or small business ventures. Proper documentation, including pay stubs, W-2 forms, or detailed records of cash payments, is crucial. For self-employment income, maintain a log of services provided, dates, and amounts received. IRS Publication 929 offers guidance on tax rules for children and dependents, which can help clarify income documentation requirements.

Tax Reporting Considerations

Managing a Roth IRA for a minor involves understanding the tax implications. While contributions are not tax-deductible, the minor’s earned income must be reported accurately to qualify for contributions. If the child has other income sources, the Kiddie Tax might apply if unearned income exceeds the annual threshold, potentially subjecting it to the parent’s tax rate. Early withdrawals from the Roth IRA before age 59½ could trigger taxes and a 10% penalty unless exceptions apply, such as for first-time homebuyers or qualified education expenses. Careful reporting ensures compliance and avoids IRS inquiries.

Contribution Rules

Roth IRA contribution rules require adherence to IRS guidelines. The annual contribution limit is the lesser of the individual’s earned income or a set dollar amount, currently $6,500 for individuals under 50. For minors, contributions are capped at their total earned income if it’s below this threshold. Parents often match their child’s contributions—for example, if a child earns $2,000 from a summer job, a parent might contribute an additional $2,000 into the Roth IRA. This approach maximizes contributions while teaching financial discipline. Staying informed about annual IRS contribution limits and rules is critical for effective planning.

Distribution Requirements

Roth IRAs promote long-term savings by allowing tax-free growth with no required minimum distributions during the account holder’s lifetime. Qualified distributions—those that are tax-free and penalty-free—require the account to be open for at least five years and the account holder to be 59½ or meet specific exceptions, such as first-time home purchases, qualified education expenses, or significant medical costs. For minors, planning withdrawals for future needs like college tuition or a home down payment can align with these exceptions. Parents and guardians should familiarize themselves with these rules to ensure compliance and avoid penalties.