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

1. Setting Your Kids Up for Financial Success: The Power of a Roth IRA

Starting your children on the right financial path early in life can have a transformative impact on their future. One of the most effective ways to do this is by opening a Roth IRA for your kids. If your child has earned income—whether from a part-time job, babysitting, or even dog walking—they are eligible to contribute to a Roth IRA. The best part? They don’t even need to use their own money. Parents, grandparents, or any relative can contribute to the IRA on their behalf, making it a family effort to build a secure financial future.

While you could opt for a traditional custodial IRA, the Roth IRA is generally the better choice, especially since most minors don’t have significant taxable income. Roth IRAs allow after-tax contributions, which means your child’s earnings will grow tax-free and can be withdrawn tax-free in retirement. This makes it an ideal savings vehicle for young people who are likely to be in a higher tax bracket later in life.

2. How a Custodial Roth IRA Works

A custodial Roth IRA is essentially a regular Roth IRA, but it’s managed by a parent or guardian for the benefit of a minor. The process begins with opening the account at a qualified financial institution, where the custodian (usually a parent) oversees contributions and investments. The custodian retains control until the child reaches the age of majority, which varies by state (typically 18 or 21). At that point, the account is transferred into the young adult’s name, giving them full control over their savings.

For this strategy to work, it’s essential that the child has earned income. This can come from formal employment, like a summer job, or self-employment income, such as freelance work or running a small business. Keeping detailed records of your child’s income and IRA contributions is crucial in case of an audit or if early withdrawals are necessary. Starting this process early ensures that your child’s savings have decades to benefit from compounding, setting them up for long-term financial success.

3. Making Millionaires: The Magic of Roth IRAs for Kids

Opening a Roth IRA for your child is more than just a smart financial move—it’s a gift that could make them a millionaire by retirement. The key to this strategy lies in the power of compounding, which works best when given time. By starting early, even modest contributions can grow exponentially over decades.

Consider the example of Finley, a 16-year-old who earns $10,000 per year from part-time jobs and has her parents contribute $7,000 annually (the IRS contribution limit in 2025) to her custodial Roth IRA. By the time she turns 21, the account is in her name, and she continues to contribute $7,000 each year throughout her twenties. Once she reaches a higher income bracket and can no longer contribute to a Roth IRA, she shifts her focus to other retirement savings strategies.

Over the years, Finley and her parents contribute a total of $98,000 to her Roth IRA. Assuming an annual return of 7%, by the time she turns 65, her account would grow to nearly $1.9 million. This remarkable result is achieved simply by giving her savings 50 years to grow. Imagine the financial freedom this kind of nest egg could provide!

4. Special Features of Roth IRAs

One of the most appealing aspects of Roth IRAs is their tax advantages. Contributions are made with after-tax dollars, which is especially beneficial for children because their income (and therefore their tax rate) is typically low. This means your child’s contributions are taxed at a rate of 0%, setting them up for tax-free growth and withdrawals in the future.

The money in a Roth IRA grows tax-deferred, just like in a traditional IRA or 401(k). When withdrawals are made in retirement (provided the account has been open for at least five years and the account owner is 59½ or older), the funds are entirely tax-free. This makes Roth IRAs an excellent way to build wealth over time. Additionally, Roth IRAs don’t have required minimum distributions (RMDs), unlike traditional IRAs and 401(k)s, which means your child can keep the money in the account for as long as they want without being forced to take withdrawals.

Roth IRAs also offer flexibility for emergencies or other needs. While the goal should be to leave the money untouched until retirement, account holders can withdraw their contributions (not the investment earnings) at any time for any reason without facing taxes or penalties. This feature can provide peace of mind, knowing that the funds are accessible if needed.

5. Maximizing the ROI on Your Child’s Earned Income

A Roth IRA for your child is not just a smart financial move—it’s also an opportunity to teach them valuable lessons about money management and investing. By contributing to a Roth IRA, your child learns the importance of saving and the power of compounding. These lessons can set them up for a lifetime of financial literacy and responsibility.

The earlier you start saving, the better the return on investment will be. Even small, consistent contributions can add up over time, thanks to the magic of compounding. For example, if your child starts contributing just $100 a month at age 15 and earns a 7% annual return, they could have more than $1 million by retirement. This kind of growth is achievable with minimal effort and dedication, making it a strategy worth prioritizing.

6. Conclusion: Giving Your Child the Gift of Financial Freedom

Opening a Roth IRA for your child is one of the most meaningful gifts you can give them. It not only sets them up for long-term financial success but also teaches them the importance of saving and investing from a young age. With its tax-free growth and withdrawal options, a Roth IRA provides a flexible and powerful way to build wealth over time.

By leveraging the power of compounding and taking advantage of the Roth IRA’s unique features, you can help your child achieve financial independence and security. Whether they use the funds for retirement, a down payment on a home, or other major life expenses, the money they save now will have a profound impact on their future. Start early, stay consistent, and watch your child’s savings grow into a life-changing fortune.