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Should You Consider Opening A Roth IRA For Your Child? Thumbnail

Should You Consider Opening A Roth IRA For Your Child?

Jeff Shelton

By Jeff Shelton

You may think Roth IRAs are only for working adults who have retirement on the brain. But think again! Roth IRAs are an excellent savings vehicle for kids. Yes, for kids. Here are 4 reasons why you should consider opening a Roth IRA for your child. 

1. Flexible Withdrawal Rules

Most retirement accounts charge you a steep penalty if you need to access your money before age 59½. But not Roth IRAs! You can withdraw the principal balance (aka your contributions) at any time without penalty. The growth on your money can be withdrawn without penalty after 5 years of your contribution being made and being age 59 ½ or older.

That means you can use the Roth IRA money for your kid to save up for their first car, college tuition, a dream vacation, or whatever else they want. Obviously, as a parent, you want to manage any withdrawals that are made. The account will need to be set up as a custodial account for minors.

2. Compound Interest Has Decades To Work Its Magic

There isn’t a savings account out there that can beat the amount of interest your child could earn by stashing their money in a Roth IRA if we look back at historical numbers. Yes, Roth IRAs don’t offer guaranteed income, and past performance does not indicate future performance, so your child could lose their money. But history tells us a good story over a long period of time if they invest in a broadly diversified portfolio. 

Let’s say your child puts $6,000 in a Roth IRA and leaves it there for 50 years. Assuming a 6% investment return, they’d have about $120k at the end of that 50-year period—and that’s without adding a single penny to their account! Wait 10 more years, and the money nearly doubles to $218k. 

For reference, a $6,000 savings account balance earning 0.09% (the current national average) would only be worth $6,276.16 after 50 years. Which would you choose? 

3. They Can Use The Money For More Than Just Retirement

You may be shocked to know that you can use a Roth IRA for more than just retirement. For example, once an IRA has been established for at least five years, the account holder can take out up to $10,000, avoiding the possible tax on earnings and the 10% penalty for early withdrawals if they have a qualified exception, such as a down payment on their first home. Also, your kid can use their Roth IRA earnings for qualified education expenses, including college tuition.

4. It Won’t Impact Their College Financial Aid Eligibility

Retirement accounts aren’t reported as assets on the Free Application for Federal Student Aid (FAFSA), so your kid can keep stashing money in a Roth IRA without worrying about it affecting their financial aid. But keep in mind that if your child takes any Roth IRA distributions while they’re in college, this must be reported as income on the FAFSA application. Subsequently, it could impact their financial aid eligibility.

5. It’s An Opportunity To Learn Valuable Financial Lessons

From a young age, your child will be able to see what happens when they save their money. Show them account statements and even encourage them to contribute their own money when they start working. When your child starts working full-time after college, teach them about making contributions early into their 401(k), into a Roth account, or a Roth IRA while they will be in the lowest tax bracket they will (hopefully) ever be in.

What’s The Catch?  

Okay, so by now you’re thinking a Roth IRA is a surefire way to help your kid save for the future. But what’s the catch? Well, here it is: 

Your child must have earned income to open a Roth IRA. (1) Allowances and income from investments don’t count. If your kid earns income from mowing grass, walking dogs, or babysitting, don’t worry, this still counts as earned income. Just make sure you keep detailed records of the receipts in case you need proof of their employment down the line.   

The Roth IRA contribution limit for 2020 is $6,000 or the amount equal to your child’s earned income for the year (whichever is less). (2) So, if your child made $3,000 working at the bowling alley this summer, then they can’t contribute more than $3,000 to their Roth IRA. 

How We Help

There are many advantages to opening a Roth IRA for your child. Not only does it give them a head start on savings, but it teaches them valuable money lessons that most people don’t learn until much later on in life. Plus, it’s a great way to save for big-ticket items like their first car or college tuition. 

At Shelton Financial Group, we’re passionate about helping parents teach their children valuable financial lessons and equipping them with the tools that will help their children succeed. If you’re intrigued by the idea of opening a Roth IRA for your child, get started by reaching out to us at 260-436-7006 or schedule your free 30-minute Fit Call online today!

About Shelton Financial Group

Shelton Financial Group is an independent, multi-generational firm in North East Indiana that takes a team approach to addressing their clients most pressing financial concerns. SFG was founded in 1996 with the mission of helping people enjoy their wealth. Using their proprietary “One Life Formula,” the team at SFG focuses on what matters most to their clients and what they can control, integrating their wealth management needs with other aspects of their financial picture. To learn more about Shelton Financial Group and how they can help you achieve financial independence, visit them online.

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(1) https://www.irs.gov/publications/p590a#en_US_2018_publink1000230355

(2) https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-ira-contribution-limits