It's never too early to start saving for retirement. Why wait until your child becomes an adult to begin? A custodial Roth IRA is a Roth IRA for kids. Here's how it can give them a strong start on the road to retirement.
What is custodial Roth IRA?
A custodial Roth IRA is a retirement savings account set up for a minor and controlled by an adult on their behalf. The difference between a Roth IRA and a traditional IRA is that you contribute to the former with after-tax dollars, and qualified withdrawals are tax-free. Understanding these IRA basics can enhance the future benefits for minors.
How does a custodial Roth IRA work?
A children's Roth IRA functions like a regular Roth IRA, but the adult custodian makes investment decisions until the minor reaches the age of majority (usually 18 or 21, depending on the state).
Eligibility requirements
There is no minimum age for a custodial Roth IRA as long as the minor has earned income from a job reportable to the IRS. That can include work paid in cash, although the child should ideally keep a record of what’s earned.
Contribution limits and rules
The annual contribution limit for a custodial Roth IRA is the same as for a standard Roth IRA. In 2024/2025, that's $7,000, or the total earned income for the year, whichever is less.
Who can open a custodial Roth IRA?
If you're wondering ‘can I open a Roth IRA for my child’ then the answer is yes. A parent, legal guardian, or other appointed custodian can open an account on behalf of a minor. They must manage the account in the minor's best interests.
What happens when the minor reaches adulthood?
Minors gain full control of the custodial account when reaching adulthood. The custodian's management role ends, and the former minor can make all decisions regarding the account. The financial institution will require the minor to submit a request that includes proof of age and identification before they can take control.
Benefits of custodial Roth IRA for minors
A custodial Roth IRA enables a custodian to deliver several benefits to a minor before they come of age, setting them up for financial success in adulthood. These include:
Tax-free growth
Like pre-tax retirement accounts, contributions to Roth IRAs grow tax-free, enabling the minor to accumulate more wealth over time.
Compound growth
The earlier that a person begins saving, the better. Earnings from investments can compound throughout childhood, increasing the eventual account balance significantly.
Financial education for minors
Financial education for minors is a powerful asset for minors. The IRA gives minors an opportunity to learn about investing and personal finance early on.
Flexible contribution withdrawals
The custodian can withdraw contributions (but not earnings) from a custodial Roth IRA at any time without penalties, giving the minor liquidity to access some of their funds when needed.
Versatile use of funds
A custodial Roth IRA provides some financial flexibility for the owner. Subject to certain conditions, they can even use earnings from a qualifying custodial Roth IRA for certain purposes other than retirement, such as a first-time home purchase.
Who can open a custodial Roth IRA?
While a custodial Roth IRA is useful for minors, it also carries some downsides. Firstly, while it does offer some access to the funds, non-qualified withdrawals of earnings before age 59 1/2 may incur taxes and penalties.
Does a custodial Roth IRA impact college aid?
A custodial Roth IRA can impact eligibility for financial aid in college, but only if money is withdrawn from it. Although the funds in the account are not considered parental assets, any distributions taken from the Roth IRA count as income on the Free Application for Federal Student Aid (FAFSA) in the year they are withdrawn. This might lower the aid a student can expect.
How to set up a custodial Roth IRA
Before opening a custodial Roth IRA for your child, ensure that they have the income to contribute. Then, choose a reputable institution known for good customer service and strong financial stability. Consider factors including account maintenance costs and trading fees. Check the breadth of investment options from your potential custodial Roth IRA provider, and evaluate the management options, including online and mobile apps.
Determine how much you want to contribute to the custodial Roth IRA, and consider encouraging your minor to save consistently by setting up automated regular contributions.
Custodial Roth IRA vs. UGMA/UGMA accounts
A custodial Roth IRA and a UGMA/UGMA account are both owned by minors and administered by a custodian. While the former is specifically for retirement, a UGMA/UTMA account is for generic savings. This could tempt minors to spend the money on other things when they come of age, so a custodian wanting to guide the minor towards retirement savings might prefer a custodial Roth IRA.
There are also differences in tax rules and contribution limits. While Roth IRA earnings offer tax-free growth and withdrawals in retirement, UGMA/UTMA accounts do not. Unlike Roth IRAs, UGMA/UTMA accounts have no contribution limits.
Frequently asked questions
Can minors withdraw money from custodial Roth IRA?
Minors can only withdraw funds directly when they come of age. Before that, the custodian would have to agree.
What happens if a minor doesn’t have earned income for one year?
Without earned income in a given year, a minor cannot contribute to a traditional or Roth IRA.
Are there penalties for early withdrawals?
If an account holder is under 59 1/2 or withdraws earnings before the account has been open for five years, the earnings are subject to both income taxes and a 10% early withdrawal penalty. However, the owner can withdraw contributions at any time without penalties or taxes. There are some exceptions to the penalty, such as for first time home purchases, qualified education expenses, or certain other situations.
Key takeaways
A custodial Roth IRA is a great way to help start a child on the road to retirement. It offers tax-free growth and some flexibility while also keeping those retirement funds under parental control until the child comes of age.
When exploring a custodial Roth IRA as an option, think carefully about the amount of earned income that your child will have, and whether it is likely to exceed the contribution limit. Evaluate the potential fees and consider the custodial Roth IRA as part of the longer-term financial plan for your child, including college plans. Handled properly, a custodial Roth IRA will be a valuable contribution to your child's financial future.
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