Should You Set Up a Roth IRA for Your Kids?

Many of us got our first jobs as teenagers. Some may have started working even earlier, especially if it was part of a family business. Working at a tender young age is an American tradition. So, why isn’t the idea of kids contributing to their own IRAs a tradition? We think it should be. In fact, it’s a really good idea!

Here’s what you need to know about individual retirement accounts (IRAs) for children. Let’s focus on the Roth IRA option.

Roth IRA Contributions

There is only one federal income tax law requirement for a minor to make an annual Roth IRA contribution. They must have earned enough income during the tax year to cover the contribution. In other words, they can’t contribute more than they actually made. Otherwise, age is completely irrelevant.

If a child earns some cash from a summer job or part-time work after school, he or she is entitled to make a Roth contribution for that year. For the 2021 and 2022 tax years, your working child can contribute the lesser of:

• His or her earned income for the year; or
• $6,000

While the same $6,000 contribution limit applies equally to Roth IRAs and traditional IRAs, the Roth option is usually better for kids. You should also know that your child’s contribution for the 2021 tax year can be made as late as April 15, 2022, so it’s not too late to set up an account and start contributing.

Long-Term Gains

We all know the key long-term advantages of IRAs. You can make tax-deferred contributions now. Then, the funds can continue to grow over time through investment earnings. Starting these contributions at an early age is really smart, especially if they aren’t spending the money right away. It’s a better long-term solution than a traditional savings account with a very low interest rate. Just a few contributions during your kid’s teenage years can potentially accumulate to quite a bit of money by their retirement age.

Realistically, most kids won’t be willing to contribute the $6,000 annual maximum, even if they are making enough to do so. They want that money to have fun, buy their first car or maybe even save for college expenses. Still, any amount they are able to contribute will go a long way in a Roth IRA.

Let’s say the child contributes $2,500 each year over a four-year period. Assuming a 5% annual return, the Roth account would be worth about $82,000 in 45 years. If the rate of return is even higher, then the gains are exponential. An 8% return over 45 years would accumulate to a whopping $259,000!

A Smart Financial Idea

It’s a simple, yet brilliant financial planning option. With relatively modest annual contributions by your children for just a few years, Roth IRAs can be worth eye-popping amounts by the time they grow up and reach their retirement age.

To learn more about Roth IRAs and other financial planning ideas for your entire family, contact Illumination Wealth today. Let us help guide you and your children on the journey toward financial freedom.