If your child earned income in 2020, there's a special offer that you can take advantage of before the tax deadline. It's called the Roth IRA (individual retirement account) and it could be key to helping your child become a millionaire before retirement.
Beat the tax deadline for Roth IRA contributions
The Roth IRA is one of the most attractive accounts on the planet, giving savers built-in benefits they can use throughout their lifetime. Even kids can start racking up on perks now and cash in on them later.
The Roth IRA allows you to contribute money you've already paid taxes on, invest in company stocks you love, and watch your money grow tax-free. After you've reached 59 1/2 and you've met the five-year rule, you can withdraw every penny earned in the account without worrying about the IRS taking a bite of your profits. If you own dividend-paying companies in your Roth IRA, you'll be able to obtain an extra stream of income for life -- as long as the company's board of directors continues to declare a dividend.
When you open a Roth IRA for your child, it's best to contribute as much as you can every year. For 2020 and 2021, you can contribute up to $6,000 to a Roth IRA account in your child's name. Once the deadline for contributions has passed, you can't turn back and make a contribution for a prior year.
Fortunately, there's still time to contribute to your child's Roth IRA for 2020. The deadline to contribute to an individual retirement account is the same day that federal income tax returns are due. The IRS pushed the 2020 filing date from April 15, 2021 to May 17, 2021. This gives you a little more time to stash some cash away for your child's future.
Make sure your kids qualify
One incredible benefit of a Roth IRA is that it's open to savers of all ages. You just need to have earned income for the year to make a contribution. That's easy for teenagers with after-school or summer jobs to get, but in some cases, even younger children can earn money that will allow them to qualify to contribute to a Roth IRA. Consult a tax professional to ensure that any income your child gets will count for Roth IRA contributions and that it's documented and reported correctly.
In most cases, a child cannot open a Roth IRA in their name until they are 18. A parent, guardian or another adult can serve as a custodian and manage the account on the child's behalf until they are eligible to manage their own account.
Although age is not a barrier, there's another number that can stand in the way of your child's Roth IRA goals: income. Every year, the IRS releases income limits. If your child earned too much money in 2020, they are not eligible to make direct contributions to a Roth IRA. Since most kids usually don't have six-figure earnings, this won't be much of a concern.
On the other hand, if your child only made a few thousand dollars last year, you cannot contribute the full $6,000 to a Roth IRA on their behalf. Roth IRA contributions cannot exceed the amount of income earned for the year. So if your child made $4,000 last year, you can only contribute up to $4,000 to a Roth IRA on behalf of your child.
Get a head start on financial success
Setting a strong foundation is key to financial success. By contributing to your child's Roth IRA for 2020, you have a chance to sweeten the pot of rewards that your kids can access later.
Your kids will benefit from the power of time working on their side. Every year, your child's money has a chance to grow through compounding. That money can be used to pay for college, buy a home, or fund an emergency. A Roth IRA can serve as a backup source of funds because you can always withdraw what you contribute. But if you're still on the fence about making a Roth IRA contribution on behalf of your child, do an analysis of the pros and cons. One huge win is knowing that your child will gain a head start on the path to building wealth.