Establishing a Roth IRA for young children is a strategic approach to fostering their financial well-being and can provide significant benefits.
As of 2024, individuals under the age of 50 can contribute a maximum of $7,000 to any IRA, including Roth and traditional accounts, or a combination of both.
If a child’s earned income falls below this threshold, contributions are limited to the amount they have earned, with no allowance for “gift money.”
While children must have earned income to make contributions, the funds for the Roth IRA can be provided by others. This arrangement allows the child to retain their earnings for immediate needs while the Roth IRA is funded independently, thereby establishing a financial base without requiring personal expenditure.
➡️ Important Note: Parents, grandparents, or any family member can initiate a Roth IRA for a child, and there is no age limit for contributions; any child who earns income is eligible for a Roth IRA. However, if the child is under 18 or 21 in certain states, a parent or guardian must create a custodial Roth IRA in the child’s name and oversee the investments until the child reaches the legal age.
🛑Although the custodian manages the account, the child is the beneficial owner, meaning the funds must be utilized for their benefit.
Income Criteria
To qualify for contributions to a Roth IRA, the child must have earned income, which can stem from traditional jobs like part-time work or self-employment endeavors such as babysitting or lawn care.
🛑Payments received from parents for chores or as allowances do not qualify, nor do cash gifts. Most young children are unlikely to reach the $7,000 maximum annual contribution limit set for 2024 and will be restricted to the total amount they earn throughout the year.
Even if a child is not obligated to file an income tax return, it is essential for the parent or guardian to maintain detailed records of any earnings that contribute to the Roth IRA.
Self-employment income may incur additional taxes, such as Medicare and Social Security, so it is advisable to consult a tax professional to ensure compliance and optimize benefits.
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Roth IRA: Exploring the Advantages
At Wave Tax, we consider the Roth IRA as a distinctive savings vehicle for young individuals, offering both tax advantages and liquidity.
While a Roth account serves as a long-term savings option, it also provides access to contributions without penalties in case of emergencies, which is particularly beneficial for young people who have many years until retirement.
✅ A key advantage is that contributions are made with after-tax dollars, allowing for tax-free withdrawals during retirement, provided specific conditions are met. This is particularly beneficial for children, who are often in a low or zero tax bracket, enabling their investments to grow without the burden of taxes.
📌 Moreover, starting contributions early allows the account to take advantage of decades of compound interest, significantly increasing the total balance over time. For instance, if a 15-year-old contributes $2,000 each year until they turn 65, with an average annual return of 7%, the account could potentially reach nearly $1 million.
Unlike traditional IRAs, contributions to a Roth account can be withdrawn at any time without incurring penalties or taxes. Additionally, under certain conditions, even earnings can be accessed without penalties, such as for purchasing a first home.
➡️ Important Note: Another benefit of Roth IRAs is that they do not mandate withdrawals at a specific age, allowing the account to continue growing tax-free for as long as the owner desires. This feature provides young individuals with greater control over their retirement savings and can be advantageous in managing their retirement income.
Establishing a Roth IRA also provides young individuals with the opportunity to develop essential skills in investing, saving, and financial planning early in life.
The design of a Roth IRA promotes a long-term perspective on financial management, aiding young people in creating a stable financial future.
✅ And remember, at Wave Tax we offer the tax advice you and your children need.
📍Contact us at info@wavetax.us