If you're trying to accelerate your child's wealth-building potential, a Roth IRA (individual retirement account) might do the trick. Although retirement planning might be the last thing on your mind when raising a child, it could be your child's golden ticket to $1 million.
If you're thinking about opening a Roth IRA for your child in 2022, here are a few things to consider.
Tap into the benefits of a Roth IRA
A Roth IRA is a special retirement account that allows you to pay taxes on your money upfront in exchange for tax-free growth and withdrawals during retirement. It's a sweet deal, especially if you start contributing early. The best part is that the Roth IRA does not come with age restrictions, so it's possible to open a Roth IRA for your child as soon as they start earning money.
Let's say your child is 11 years old and earns money as a babysitter. You or another adult can open a custodial Roth IRA at a financial institution that offers accounts for minors. An adult manages the account until the child is eligible to take control of the account (age 18 in most states). When your child reaches 59 1/2, all the money accumulated in the account will be 100% tax-free.
If you expect your child to make big bucks later in life, a Roth IRA is worth considering now. As soon as your child's income exceeds the annual income limits, they will no longer be eligible to make a direct contribution to a Roth IRA.
Contribute as much as possible
If you open a Roth IRA for your child, you should try to contribute as much as you can to maximize your child's benefits. For 2022, you can contribute up to $6,000 to a Roth IRA on behalf of your child. Your child can also use their own money to contribute to the account.
There's no pressure to contribute the maximum amount every year. You can contribute $0, $2,000, or $6,000 in 2022. It's up to you. However, you can never contribute more than your child's earned income for the year. For example, let's say your child only earned $3,000 from modeling gigs. Your contribution to your child's account is limited to $3,000 for the year.
A smart way to save
Contributing to a Roth IRA beats setting money aside in your child's piggy bank. Let's say you save $6,000 starting when your child is 11 years old. After 10 years, there will be $60,000 in the piggy bank.
If your money is consistently invested in a Roth IRA, your child can take advantage of tax-free growth and compounding. Essentially, that's when your money is earning more money. Your child can start investing in exchange-traded funds or their favorite companies to supercharge their portfolio potential.
Let's say you contributed $6,000 each year for 10 years, and earned a 7% average annual rate on your investments. The account would be worth a little over $83,000 when your child turns 21. Wait another 30 years, and your child's investments could be worth more than $1 million.
The ultimate decision
If you're on the fence about opening a Roth IRA for your child, consider these benefits:
- Funds can be used to help your child pay for college penalty-free.
- Up to $10,000 can be used to build or purchase a new home without incurring taxes or penalties.
- Every penny contributed to the account can be withdrawn at any time.
You also want to weigh the pros and cons of having a 529 education savings plan versus a Roth IRA. Talk to a tax professional to determine which accounts make sense for you and your child's goals.
One step closer to generational wealth
Your child's wealth-building capacity won't be solely based on what career they choose and how much money they earn. How your child allocates their money will determine how financially secure they are in the future.
Before you get started with a Roth IRA for your kids, evaluate the benefits and determine what makes sense for your financial situation and goals. The sooner you start allocating money toward your child's future, the more time you'll have to help your kids reach the million-dollar mark.