All About Roth, Part III: Opening a Roth IRA for Your Child

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By the way, a great toy for older kids to teach about money and math. Not so great for younger kids

My mom recently suggested we try to make my second child a baby model because her friend’s grandson, who is not nearly as cute as our baby (her words not mine), was recently a model for OshKosh.  Lol.  She and I like most every other grandmother and mother duo believe our child is the cutest baby ever.  Other than the good laugh I had imagining my 7 month old baby posing as a baby model for Calvin Klein or Burberry, my mind also wandered to another thought–the thought that if she really did work as a model and earned some money, we could open a Roth IRA for her!  I’m probably the only mom who has these thoughts.  Most other moms probably fantasize about their child securing a national commercial or becoming a big star and I fantasize about opening a Roth IRA for her.

Opening a Roth IRA for your child, bet you didn’t think of that one.  Or maybe you did and that’s how you ended up on this page.  There’s nothing in the IRS verbage about a minimum age required to open a Roth IRA.  The only requirement to opening a Roth IRA is that you must have earned income (its gotta be earned income, not income from investments).  There’s also an income limit, modified adjusted gross income (MAGI) of $117,000–$132,000 for 2016, though most parents probably won’t have to worry about their kids making this much money as a minor. =P  Anyways, if your kid has somehow made any earned income, instead of letting them spend it all or just sticking that money in a dull old savings account or even a custodial account, there’s some unique advantages to opening a Roth IRA for them instead.

Triple Tax Advantage: Unlike the rest of us who pay taxes on almost all of the money we earn, children who earn income from a part-time job or side gig probably won’t have to pay any taxes on their earnings.  That’s because the first $6300 of earned income for a child will fall into the 0% tax bracket.  If you then invested that money (up to $5500, the maximum contribution limit for Roth IRA for 2016) into a Roth IRA, your child is getting a very rare triple tax advantage.  (1) They earned income tax-free,  (2) that tax-free money gets to grow tax-free inside the Roth IRA and (3) they can later withdraw it tax-free starting age 59.5.  How awesome sauce is that?  Only a health spending account (HSA) also has a triple tax advantage like this, where basically the money you invest never gets taxed!

Longer timeline for compound growth = wealth. Another huge advantage to opening a Roth IRA for your child is the longer timeline that money has to grow and compound.  Albert Einstein is quoted as saying “Compound interest is the greatest mathematical discovery in the world.”  Remember this graph from JP Morgan Asset Management on about the power of compound growth in retirement savings?  The earlier you begin investing, the more benefit you reap with less work and money.  Compound interest is earning money on your earnings.  It’s literally having your money work for you.

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JP Morgan actually has an updated version of this graph now, but I still think this one is better.

Additionally, since your child is young, they can afford to invest more aggressively, which generally has greater returns associated with it over the long-term.  A longer timeline for compound growth and higher risk investments mean when you’re little Madison or Ethan turns 59.5 years old, they will likely have quite a little stash of completely tax-free money waiting for them, especially if they continue to add to their Roth goldmine by contributing regularly along the way.  Take this simple example, if you opened a Roth IRA for your child at age 15 with a one time contribution of $5500 (assuming they made that much, since you can only contribute up to what you made and no more than $5500 for 2016) and assumed a 8% yearly return, even if they never contributed another dollar to the Roth, it would still grow to over $175,000 by the time they turn 60 years old.  And because they don’t have to pay any taxes on it, they actually get to keep every penny of it too.

Does It Count Against Financial Aid Eligibility?  You might wonder if opening a Roth IRA in your child’s name might hurt their financial-aid eligibility and luckily it appears the answer is no.  Retirement accounts such as Roth IRAs, traditional IRAs and 401ks are not reported on the FAFSA and therefore won’t be counted in the financial-aid eligibility calculation as long as your child doesn’t make any withdrawals from the Roth IRA.  If you recall from Part I of the All About Roth series, the owner can withdraw the contribution portion of a Roth IRA at anytime without paying taxes or penalties.  However, if take withdraw any of the earning’s portion, they will be subject to a 10% penalty and taxes on the distribution.  If they take any money out from their Roth IRA while they are in college or graduate school, it will seriously affect their financial aid eligibility since it will count as their assets and not parental assets.  So remember to also teach your child about how a Roth IRA works and hopefully they’ll be wise enough to save it til they are at least age 59.5.

So, do you have a baby model or working child in your family?  Why not have them open a Roth IRA and teach them a lesson on compound interest and growing wealth.  If you’re child is older, some parents like to do a matching contribution where they let their child spend the money they earned, but contribute the matching amount into a Roth IRA in their name.  That way your child gets to have his/her cake and eat it too.  Yum, cake.

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