Should Your Kids Have A Roth IRA? How A Custodial IRA Works.

Start your kids on the right financial foot by saving for retirement early with a Roth IRA. If your child has earned income, perhaps from a part-time job, they can contribute to a Roth IRA. Even better: the child or teen doesn’t have to part with their hard-earned cash. IRA contributions can come from a parent, grandparent, relative…anyone. While you could open a regular custodial IRA and make pre-tax contributions, since most minors don’t have meaningful taxable income, a Roth IRA is almost always a better savings vehicle.

How A Custodial IRA Works

A custodial Roth IRA is a regular Roth IRA account, but for the benefit of a minor. Parents can open an account with any qualified financial institution. The child’s Roth IRA stays in the care of the parent (the custodian) who will direct contributions and investments for the benefit of the child or teen.

Once the kid reaches the age of majority (18 or 21 depending on the state), the assets must be released to the young adult, which happens when the account is put in their own name.

Again, remember, for this strategy to work the child must have earned income. Wages can come from formal employment, like a summer job, or self-employment income, such as babysitting or dog walking. Good recordkeeping is important. Keep track of your child’s earned income and contributions to the IRA in the event of an audit or to help with tax calculations if there are early withdrawals.

Making Millionaires: Roth IRAs For Kids

Why open a Roth IRA for your kids? There are a million reasons! Because of the benefits of compounding, starting Roth IRA contributions early in life can significantly change their financial situation in retirement. Over decades, compounding allows your invested dollars to work much harder for you than if you were only invested for a shorter time horizon.

Here’s an example of compounding in action:

Finley is 16 years old and works at restaurants throughout high school and college. She earns $10,000 per year and her parents put $7,000 (IRS contributions limit in 2025) in her custodial Roth account. When Finley turns 21, the account is in her name, and she makes the full $7,000 contribution herself throughout her twenties. By age 30, she earns too much to contribute, and shifts focus to pre-tax retirement planning due to her higher tax bracket.

Between ages 16 to 29, Finley and her parents have contributed a total of $98,000 to her Roth IRA. Assuming a 7% annual rate of return, by age 65, her account would be worth nearly $1,930,000. She has been investing for 50 years.

Special Features Of Roth IRAs

After-tax contributions

Contributions to Roth IRAs are made with after-tax dollars. Since your child’s earnings are probably limited (especially compared to future earnings), this often means paying tax at a 0% rate. Can’t beat zero.

Tax-deferred growth and tax-free withdrawals

Growth in the account is tax-deferred like a traditional IRA or 401(k), so it’s not taxed every year. When the funds are taken out, assuming at least five years have passed since the first contribution was made and the account owner is at least age 59 ½, withdrawals are tax-free.

Thus, investments effectively grow tax free. Early withdrawals may be subject to income tax on investment growth and a 10% penalty, though there are some exceptions. Though the goal should be to avoid tapping the account until retirement, a Roth IRA allows the account owner to take out their contributions at any time and for any reason, without taxes or penalties.

No required minimum distributions

Unlike traditional IRAs, 401(k)s, and all other types of retirement accounts, there are no required minimum distributions (RMDs) on Roth accounts. Without mandatory withdrawals, a Roth IRA can be a great way to add flexibility and tax diversification in retirement.

Maximize The ROI On Your Child’s Earned Income

A Roth IRA for kids can help your child start saving for retirement and investing for the future. It’s also a terrific time to teach kids about financial literacy and investing. As illustrated in the simple compounding example, the return on investment can be significant! With a little effort and some dedication to saving at an early age, opening a Roth IRA for kids has real potential to make a meaningful difference in their financial situation.