Using IRAs to Help Children in 5 Easy Steps
Roth IRA • 4 min read
Can children have IRAs? The answer is yes—there is no minimum age requirement for having an IRA. Due to the remarkable power of compound interest, saving tax-free in an IRA from childhood can provide a significant head start on financial security. For example, saving $7,000 in an IRA annually from age 14 through 24 and earning 7% per year provides over $1 million at age 61—even without contributing after age 24!
Here are five straightforward steps to help your children build wealth through IRAs:
Step 1: Open an IRA for Every Child Who Has Earned Income
The yearly contribution limit currently is $7,000 or the amount of the child’s earned income, whichever is less. Any kind of paying work will qualify: babysitting, waiting tables, helping with the family business, and so on. Wages can come from a family business or other legitimate employment.
Important Note: For a minor child (under age 18 to 21, depending on state law), you will need to set up a “custodial IRA” or “guardian IRA” account. These are now offered by many banks and financial institutions, making it easy to get started.
Step 2: Give Children Money to Make IRA Contributions
If children want to spend their income from working, that’s perfectly okay. You can gift money to children to fund IRA contributions. This allows them to enjoy their earnings while you help them build long-term wealth through IRA contributions.
This strategy enables children to learn about spending and budgeting with their earned income, while you simultaneously help them establish a foundation for their financial future through tax-advantaged savings.
Step 3: Use a Roth IRA
Contributions to Roth IRAs can be withdrawn at any time for any reason with no income tax or early withdrawal penalty resulting, creating savings available at any time. Plus, investment gains in a Roth IRA can eventually be withdrawn completely tax-free in retirement.
In contrast, distributions from traditional IRAs are taxable and subject to a 10% penalty before age 59 ½. The deduction for contributions to traditional IRAs is worth little or nothing when a child is in a very low or 0% tax bracket.
For children with minimal or no tax liability, a Roth IRA is almost always the better choice, providing tax-free growth and flexible access to contributions when needed.
Step 4: Invest the Roth IRA for the Long Term
Although stocks have averaged a 7% real return historically, they can be volatile, creating risk for persons in or near retirement years. Children need not fear this risk because they have a long time horizon ahead of them.
Too safe investments can actually be costly for them. A steady, sure 3% return from bond-like investments reduces the $1 million in our earlier example to only $229,000—demonstrating the significant impact of investment choices over time.
For children with decades until retirement, a well-diversified portfolio with appropriate stock exposure can provide the growth potential needed to maximize the power of compound interest.
Step 5: Keep Good Records for Children
Make sure a child’s income is “on the books” and reported on a parent’s or the child’s own tax return. If the child’s income comes from a family business, document that it is genuinely earned work, and monitor the IRA’s investments carefully.
Proper record-keeping is essential for:
- IRS compliance and documentation
- Tracking earned income for contribution limits
- Demonstrating legitimate employment if audited
- Monitoring investment performance over time
This is exactly where Roth Wizards can help. Our platform makes it easy to track your child’s work, document their earnings, and maintain proper records for both tax purposes and IRA contributions.
The Power of Starting Early
The example of saving $7,000 annually from age 14 through 24 and reaching over $1 million by age 61 illustrates the incredible power of starting early. Even if your child contributes smaller amounts, the principle remains the same: time is one of the most valuable assets in building wealth.
By following these five steps, you can help your children establish a strong financial foundation that will benefit them throughout their lives. The combination of earned income, Roth IRA contributions, long-term investing, and proper record-keeping creates a powerful wealth-building strategy for the next generation.