What Is a Minor Roth IRA? Can I Contribute Funds for My Child?

6.5 MIN READ

Most kids don't think about retirement or fully understand it, but as parents, you can open a minor Roth IRA for your child and start their retirement funds early. An IRA can be one of the greatest gifts you give your child, even if they don't understand or recognize it yet. Then, when they hit adult years and realize the value of what you've done, they'll be grateful.

Read on to learn what a minor Roth IRA is and how it works.

What Is a Minor Roth IRA?

A Custodial Roth IRA for kids is just like a regular IRA for adults. It sets aside money after-tax for retirement. If you start a Roth IRA for your child now, it has up to 47 years to grow, depending on what age you start it.

The funds grow tax-free, and as long as your child doesn't withdraw money until age 59 ½ or older, the money withdrawn is tax-free too.

How Does It Work?

To open a minor child's Roth IRA, your child must earn income. It doesn't matter where they work. It could be for the local ice cream shop, babysitting for a neighbor, or cutting lawns - it all counts.

As long as your child claims the income and pays taxes on it, they can contribute funds to a minor Roth IRA. The funds that are deposited into the custodial Roth IRA are post-tax. This means that it is not considered taxable income when they withdraw it in the future. So, the tax advantages of not having to pay income tax in the future with higher rates is a great bonus. Like adult IRAs, minors can contribute up to $6,000 per year in Roth IRA contributions, but no more than they earn. Therefore, $6,000 is the annual contribution limit.

Say, for example, your child earns $3,000 this year. They can contribute up to $3,000 in their Roth IRA.

Once your child is over 18, they must convert the account from a custodial Roth IRA or minor account to a standard Roth IRA. Make sure your child understands the account, how it works, and most importantly, how to keep contributing to it.

Pros and Cons of the Minor Roth IRA

Pros:

Minor or Custodial Roth IRAs give your child a head start on their retirement savings. Since most adults can't afford to contribute to an IRA until they've been working for a few years, this gives them a great start.
Teaching your child about retirement funds early on gives them a head start in financial literacy. Saving for retirement will become natural for your child as they enter adulthood.
There aren't any age restrictions on your child's earned income. So as long as your child has earned income (allowance doesn't count), they can open and contribute to a Roth IRA.
Minors can withdraw contributions (not earnings) at any time after five years without penalty.

Cons:

A parent or guardian must open the minor Roth IRA for the child. Even teenagers can't open the account themselves.
Children must have earned income to open a Custodial IRA. The income must be documented too, so if they babysit or cut grass, it's best to track receipt of the money or keep a running log just in case.
All investing involves risk, so research must be done thoroughly before investing money, whether it's a regular Roth IRA or Custodial IRA, for children to start investing early.

Related Article | Can I Roll an RRSP into an IRA?

What's the Difference Between a Minor Roth IRA and a Minor IRA?

A minor Roth IRA and traditional IRA are both retirement accounts that set your child up during retirement, but some major differences are.

Traditional IRA Funds Are Pre-Tax

Your child will get the tax break in the year they contribute to a traditional IRA versus contributing post-tax in a Roth IRA. This lowers your child's tax liability today but likely increases the amount of taxes they will pay in retirement.

Chances are your child is in a much lower tax bracket today than they will be during retirement. This could mean paying more taxes on the funds.

Kids Can Use Minor Roth IRA Funds Early

If your child wants to use some of the funds in the Roth IRA early (not recommended), they can. There aren't any taxes or penalties if your child withdraws ONLY the funds contributed, not the earnings. It is not penalty-free, however. If a child withdraws funds from a traditional IRA early, they will pay a 10% penalty plus the taxes owed.

Roth IRAs Don't Have Required Minimum Distributions

Traditional IRAs require retirees to take out a certain amount of their retirement funds every year after age 72. This can cause a higher tax liability than anticipated. Roth IRAs don't have required distributions which allow retirees to plan their withdrawals better to minimize their tax liabilities.

Who Else Can Contribute to a Minor Roth IRA?

Anyone can contribute to a minor Roth IRA for kids. However, the total contributed cannot exceed the child's total earnings or $6,000 per year, whichever is less.

For example, if your child earned $3,000 this year, you or your child (or anyone else) can contribute a maximum of $3,000.

Some parents match their child's contribution or even let their child do what they want with the money earned, while the parent contributes the amount they earned to their Roth IRA.

Does a Minor Roth IRA Affect a Child's Financial Aid?

Most assets affect a child's ability to secure financial aid for college, but retirement assets are exempt from this requirement. You or your child don't have to disclose retirement assets, so it won't hurt your child's ability to get financial aid.

Can a Minor Withdraw IRA Funds Early?

Any minor can withdraw up to their contributions early, but after the funds have been in the account for five years. If a child withdraws more than the amount they contributed, though, they'll pay taxes on the amount.

There are a few reasons children can withdraw Roth IRA funds early, but there may be a penalty.

Down Payment on a House

Using retirement funds for a down payment on a house can be an excellent investment. Homes appreciate, and if your child saves the equity for retirement, it's just about the same thing. In addition, using the funds for a down payment doesn't incur a tax liability or a penalty.

Children can withdraw up to $10,000 from their Roth IRA to pay for a down payment on a house.

Pay for College

The Custodial Roth IRA can be used for qualified education expenses. If a child needs money for college, they can use the minor Roth IRA funds. If the funds are used for qualified expenses, there isn't a penalty, but taxes will be due on any of the child's earnings spent (not contributions).

Pay For Emergencies

Life happens, and sometimes we have to reach into our retirement funds to pay for them. You don't have to justify why your child is using the funds, but they will pay a 10% penalty plus taxes on the earnings withdrawn.

Final Thoughts

A minor Roth IRA is a great way to set a child up for financial success. Even if your child can't afford to contribute to the account straight out of college, they will have the foundation set for them already.

If you set up an IRA for your child around age 14 - 15 when they start working, that gives them a nice head start on their retirement funds. With more time for the earnings to compound, your child will have a nice nest egg by the time they can afford to contribute to the account too.

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