Investing in Your Child’s Future: The Power of Starting a Retirement Account Early
Investing in a retirement account for your child might sound crazy, but it’s a powerful way to invest in your child’s future while building generational wealth. Children of any age can contribute to an Individual Retirement Account (IRA) provided they have earned income. This approach is particularly common among business owners who employ their children, allowing them to earn an income and contribute to an IRA.
The Case for Choosing Roth Over Traditional IRAs for Minors
For many minors, they don’t earn enough money to benefit from the up-front tax deduction of a Traditional IRA contribution. In contrast, Roth IRA contributions, which are not tax-deductible, offer tax-free growth and withdrawals. This is an attractive option for building a tax-efficient retirement nest egg from a young age.
Understanding Roth IRAs for Children
When a Roth IRA for children is established as a custodial account, a parent or guardian holds control over the account until the child reaches adulthood. Your child must have earned income to contribute to a Roth IRA. In 2024, the maximum contribution is the lesser of $7,000 or the child’s earned income. So, if your child earns $2,500 in a year, their maximum contribution is $2,500.
Key Benefits of a Roth IRA
Tax Advantages: Roth IRA contributions are made with after-tax dollars and are not tax-deductible. The account’s growth is tax-free, and withdrawals made at age 59 ½ or after are also tax-free.
Flexibility: While contributions can be withdrawn at any time without penalty, earnings cannot be taken out until age 59 ½, with certain exceptions for college expenses, first home purchases, and specific medical bills. A 10% penalty on early withdrawal of earnings otherwise applies.
No RMDs: Roth IRAs do not require minimum distributions during retirement, offering more flexibility in planning and using the funds.
Earning Income as a Minor
There are several ways for kids to earn income that qualifies for IRA contributions, including part-time jobs, self-employment, or working in a business owned by their parents. However, it’s important to note there are certain factors to consider when employing your children. For example, ensure they are up for the task and the job is age-appropriate. You cannot just add your child to the payroll and then not have them do any actual work.
Conclusion
Starting a retirement account for your child with a Roth IRA offers a unique opportunity to teach them about saving, investing, and the importance of planning for the future. It’s a strategy that provides them with a financial head start and contributes to your wealth transfer and generational wealth plans. As with any financial decision, it’s essential to consult with your Friedman + Huey advisor to ensure that this strategy aligns with your family’s overall financial goals and circumstances.
