The Roth IRA was created in 1997 and since has grown in popularity as a retirement savings vehicle, outside of employer-sponsored plans.
In this article, we’re going to discuss the characteristics of a Roth IRA and how it can be effectively used by teens for retirement savings.
How it’ll be structured
Since the children opening the account will be minors, the Roth IRA will be opened as a Custodial account.
The custodian (often a parent, grandparent, or guardian) will open the account for the benefit of the minor.
As the custodian, you are in control of the account until the minor reaches “the age of majority (18 or 21 depending on which state you reside). I live in Wisconsin. The age of majority is 18.
*The custodian can’t withdraw, remove, or transfer funds from the account under any circumstances.
Once of age, the child is able to do as they wish with the funds. With the correct guidance, these funds can accumulate and compound over several decades.
Adults can contribute by “matching” the teen’s earned income. The teen has to have earned income in order to open the account and make contributions.
For example, your teen earns $5,000 during the year. Theoretically, they could contribute all of it to their Roth. To encourage their money-saving habits and to show them the benefit, you tell them to save $2,500 and you match with an additional $2,500.
This provides an immediate reward/incentive to the teen and also helps illustrate how most employer-sponsored plans function.
Not only is this great for saving money, but it also instills the habit of saving. In my opinion, that’s even more important.
Additionally, if the minor can’t make a contribution (didn’t make enough, etc.) the custodian can still make contributions on their behalf.
Standard Roth Regulations
- Contribution max (for 2019) is $6,000
- Money grows tax-deferred
- Money withdrawn is tax-free
- 10% penalty if withdrawn prior to 59 ½, but there are exceptions
- Medical expenses that exceed 10% of your adjusted gross income (AGI)
- Health insurance
- Qualified higher-education expenses
- Death Distribution
- First home purchase
For a more detailed list, click this link.
Comparing to other accounts
With regard to other custodial accounts, the Roth IRA is best for retirement savings. In terms of college savings, the 529 and the Coverdell ESA are far superior. If you’re looking for simplicity and flexibility, an UTMA/UGMA account will be your best bet.
Below is a brief explanation of each, followed by links to more detailed articles previously written.
- 529 – A college savings plan that is exempt from federal taxes, if you use the funds to pay for qualified education-related expenses. Those expenses include tuition, books, room and board, computer equipment, and necessary supplies for students with special needs, as long as the student is attending at least half-time. (More on the 529)
- Custodial IRA – Like the 529, the Coverdell ESA is an education savings vehicle for K-12 and secondary education. Coverdell ESA stands for Coverdell Education Savings Account. (More on the Coverdell ESA)
- UTMA/UGMA – The UTMA and the UTMA are custodial accounts. An adult (the custodian) opens an account for the benefit of a minor. UTMA stands for Uniform Transfer to Minors Act. UGMA stands for Uniform Gift to Minors Act. The difference has to do with the age of majority, but more on that later. (More on UTMA/UGMA)
If you’re looking for an effective way to help your kids save for retirement, the Roth IRA is a great way to go. Please advise, that the child needs to have earned income in order to make contributions.