Personal finance

Op-ed: Your kids need a Roth IRA. It’s the ‘golden egg’ savings vehicle for young people

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As a financial advisor mom of three kids, I know well the power of compounded interest and the value of early work experience and learning to save and invest for yourself. 

My kids — ages 15, 12 and 11 — have been tutoring, filing, shredding, sweeping, and even researching and creating infographics for friends and our own companies for a while.

This has not only helped them develop responsible work habits and meet deadlines around their usual school work and extracurricular activities, but it also gives them hands-on experience managing an income. It teaches them at an early age the value of saving for the future and prioritizing important goals such as retirement.

For kids, that seems like eons away. But getting started early can offer tremendous advantages. Then, you might be wondering — like many of my clients do — what’s the best way to save for our kids?

I believe the answer is for them to save in their very own Roth individual retirement accounts.

How a Roth IRA for kids works

Yes, kids can have their own Roth IRA — and, just like for adults, the IRS rules are pretty straightforward. 

For 2024, the total contribution an individual under age 50 can make to any IRA account — whether Roth, traditional or some combination of the two — is $7,000. If someone’s earned income is less than that, they can contribute only up to the amount of income that they earned — no “gift money.”

While the child needs to have earned income to qualify for contributions, the money used to fund the Roth IRA can be contributed from someone else. This means the child can keep their earnings for immediate spending, while the Roth IRA is funded separately, helping them build a financial foundation without dipping into their own pockets.

Parents, grandparents or any generous relative or benefactor can set up a Roth IRA for a child. 

There’s no minimum age requirement for contributing to a Roth IRA; if a child can earn money, they can have a Roth IRA. 

But if the child is a minor — under age 18 in most states but under age 21 in some — a parent or guardian must open a custodial Roth IRA in the child’s name and manage the investments until the child reaches the age of majority. Although the custodian makes decisions on the account, the child is the beneficial owner, meaning the funds must be used for their benefit.

More about those income requirements: To contribute to a Roth IRA, the child must have earned income. This income could come from traditional employment, such as a part-time job, or from self-employment activities such as babysitting or lawn mowing. Money received from parents for chores or as an allowance does not count, nor do cash gifts. 

Most kids, at least the younger ones, are unlikely to earn the $7,000 maximum allowable annual contribution for 2024 and are limited to the total amount they earned during the year. 

Even if the child is not required to file an income tax return, the parent or other custodian must still keep careful records of the earnings that are used to contribute to the Roth. Self-employment income might be subject to additional taxes such as Medicare and Social Security. It’s wise to consult a tax professional to ensure compliance and maximize benefits.

Why I like the Roth IRA for youngsters

I think of the Roth IRA as the “golden egg” savings vehicle for young people because not only is the account tax-sheltered, it also has the benefit of liquidity.

A Roth can be treated like the long-term savings vehicle it is designed to be, but in case of an emergency, since kids have decades ahead of them before retirement, there are ways to access the contributions without penalties or other drawbacks. 

Establishing a Roth IRA for youngsters is a powerful way to set them on the path to financial security. By starting early, they can take full advantage of the benefits of tax-free growth, potentially amassing a significant retirement fund by the time they reach retirement age.

There are other advantages as well. Contributions are made with after-tax dollars, so withdrawals during retirement can be tax-free, provided certain conditions are met. This is particularly advantageous for children, who are likely in a low or zero tax bracket now, which allows them to grow their investments without the burden of taxes.

In addition, starting early allows the account to benefit from decades of compound interest, significantly growing the balance over time. For instance, if a 15-year-old contributes $2,000 annually until age 65, with an average annual return of 7%, the account could grow to nearly $1 million. 

Unlike traditional IRAs, contributions to a Roth can be withdrawn at any time without penalties or taxes, and under certain circumstances, even earnings can be withdrawn without penalties for a first-time home purchase, for example.

As another benefit, unlike traditional IRAs, Roth IRAs do not require withdrawals at a certain age, allowing the account to continue growing tax-free for as long as the owner chooses. This gives young people more control over their retirement funds and can be advantageous in managing their retirement income.

Furthermore, starting a Roth IRA can help young people learn about investing, saving and financial planning from an early age. The structure of a Roth IRA encourages a long-term outlook on finances, helping young people build a secure financial future.

— By Winnie Sun, co-founder and managing director of Irvine, California-based Sun Group Wealth Partners. She is also a member of the CNBC Financial Advisor Council.

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