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Using IRAs to Help Children in 5 Easy Steps

Using IRAs to Help Children in 5 Easy Steps

| December 10, 2020
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Can children have IRAs? There is no minimum age for having an IRA. Due to the power of compound
interest, saving tax-free in an IRA from childhood can provide a significant head start on financial security.
Saving $6,000 in an IRA annually from age 14 through 24 and earning 7% per year provides $1.16 million
at age 61—even without contributing after age 24!

1. Open an IRA for every child who has earned income. The yearly contribution limit
currently is $6,000 or the amount of the child’s earned income, whichever is less. Any kind
of paying work will do: babysitting, waiting tables, and so on. Wages can come from a family
business. Note: for a minor child (under age 18 to 21, depending on state law), you will need
to set up a “guardian IRA” account. These are now offered by many banks and financial

2. Give children money to make IRA contributions. If children want to spend their income
from working, that’s okay. You can gift money to children to fund IRA contributions.

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 Contributions to Roth IRAs can be withdrawn at any time for any reason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 Plus, investment gains in a Roth IRA can eventually be withdrawn tax free. 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.

4. Invest the Roth IRA for capital gains. Although stocks have averaged a 7% real return in
the past, they can be volatile, creating risk for persons in or near retirement years. Children
need not fear this risk, and “safe” investments can be costly for them. A steady, sure 3%
return from bond-like investments reduces the $1.16 million in our earlier example to only

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, and monitor the IRA’s investments carefully.

Copyright 2020 Ed Slott and Company LLC.  Reprinted with permission. Ed Slott and Company, LLC takes no responsibility for the current accuracy of this information.

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