If you have a child who is already earning money, did you know that you can open an IRA intheir name? Called a custodial IRA, these investment accounts start your child on the road toretirement savings early along with teaching them about finances.You control the account until your child reaches the age of majority in the state you are livingin, when the account must be turned over to them. The basic requirement is that the childhas earned income. We see a lot of young family members working in a family business andthis would qualify. Coffee shops, too! However, allowance money, gifted money or investment returns cannot be counted.
Most people start an IRA after they graduate from college and embark on a career. Butstarting one earlier can be a home run, taking advantage of compound interest for severaladditional years and instilling savings habits that last a lifetime.
You can open a custodial IRA either as a traditional IRA or as a Roth IRA, and the Roth IRAgenerally is the better option for children. They don’t need the tax deduction that comes witha traditional IRA, and they won’t have to pay any taxes on the money when they withdraw itas long as certain guidelines are met.
As the custodian you will manage the account, including making investment decisions, untilyour child reaches the age of majority. Not all institutions offer custodial accounts.In 2021, the most your child may contribute to an IRA is the amount of their total earningsfor the year, up to $6,000. (There are many other details involved, so it’s best to consult yourfinancial planner before starting a custodial account.)
Of course, you are probably saying to yourself, “There is no way my kid is going to hand overtheir hard-earned dollars to me for an investment account. They want to buy things NOWwith that money.” That’s why many parents choose a middle road — they offer to match the child’s contribution,say $3 for every $1 the child puts in, allowing them to spend most of their money. It doesn’tmatter where the money comes from as long as it doesn’t exceed the amount of earnedincome the child reports.
While IRAs are designed to produce retirement savings over the long term, you can withdrawmoney from a Roth IRA at any time. This can be a valuable way for your child to pay forcollege tuition or a first home after they become young adults.Withdrawal rules are complex, though: You can withdraw from the contributions portionpenalty-free, but if you begin to withdraw from the earnings portion prior to five years in,with certain exceptions, you will be subject to taxes and a 10 percent penalty.The following exceptions for the earnings portion will require you to pay taxes but allow youto avoid the 10 percent penalty: a first-time house (up to $10,000), disability, medicalexpenses if you are unemployed, along with education costs.
As I said, it’s a complicated area of personal finance. Consult a financial adviser or taxprofessional.