Opening a Roth IRA (individual retirement account) for a child isn't typically on a list of priorities, but it's something to consider if you want to give your child a leg up.
Any adult can open an account for a child and contribute after-tax dollars if the child has earned income from a job or other work. The real benefits start to kick in when you invest the contributions in assets that can supersize your child's portfolio over time. All the contributions made during your child's lifetime can lead to a tax-free windfall during retirement.
If it seems too premature to open a retirement account for your child right now, here are four Roth IRA benefits that might cause you to have a change of heart.
1. It can morph into an emergency fund
Most parents want to put their kids in a position to never have to stress over money. The Roth IRA makes it easy to wipe away money concerns by allowing savers to tap into contributions at any time. If you contribute a total of $25,000 over a five-year period to your child's Roth IRA, you can always dip into your account and grab the money that you've contributed as long as it's for legitimate expenses for the benefit of your child. You won't be subject to taxes or penalties when you withdraw your contributions.
Although the Roth IRA's flexibility might win you over, you should think twice before you tap into it. Once you take money out, you won't be able to go back into your account and replace the funds. Every year, the IRS imposes a limit on the amount of money you can contribute to your retirement accounts. For 2021, an individual under 50 can contribute up to $6,000.
Touching your Roth IRA funds could shrink the pot of money that can grow within your account tax-free, but there's peace of mind in knowing that the money you contribute is not locked away forever.
2. It can become a funding source for college expenses
There's a little-known perk in the tax code that allows savers to use their Roth IRA to pay for qualified education expenses even if you go beyond taking your initial contributions out. You'll bypass the 10% early withdrawal penalty, but you'll still be on the hook for income taxes associated with the earnings portion of your withdrawal. For some, that may be a better option than taking on debt. To maximize this Roth IRA benefit, make sure you understand what counts as a qualified education expense and consider the impact on financial aid and your total assets.
Essentially, your Roth IRA can double as a college savings fund if you use it strategically. If your child decides not to pursue higher education, the funds can just do what they were intended to do: create a nest egg for retirement.
3. It can be used as a down payment on your child's first home
If you consistently contribute to your child's Roth IRA, there will be a bonus waiting later: the flexibility to use funds for your child's dream home.
There's a Roth IRA exemption that allows up to $10,000 to be withdrawn to build or purchase a new home. Your child won't trigger any taxes or penalties as long as you've met the rules. Remember: You can always withdraw contributions. The $10,000 homebuyer exemption is something extra that you can tack on to your down payment. Let's say you've contributed $40,000 to your child's Roth IRA over the last 10 years. You can withdraw the entire $40,000 plus the $10,000 homebuyer exemption amount.
4. It can help your child become a millionaire
Although the Roth IRA comes with many perks that your child can enjoy before retirement, there's nothing like leaving all the money in the account and allowing the power of time to take over.
Let's say your offspring earns money as a child model. You decide to open a Roth IRA for your child at 13 years of age, and the account is consistently funded with $6,000 every year. Children (or their parents) can contribute to a Roth IRA as long as the child has legitimate earned income and as long as total income doesn't surpass limits. Because time and compound growth present an incredible union, with just a 7% annualized rate of return and no withdrawals, your children's tax-free nest egg could be worth more than $1 million before they hit 55.
By waiting to withdraw the money until after turning 59 1/2, your child will be able to keep every penny of that million-dollar Roth IRA fortune tax-free.
Give your child access to opportunities
A Roth IRA may not be the most popular vehicle to financial success, but there's one undeniable benefit that your child will gain: the option to leverage the Roth IRA during every phase of life.
The Roth IRA can be your child's companion during the college process, homeownership, and emergency situations. The best part is that it only takes a contribution of less than $25 a day to put your child on the path to a lifetime of rewards.