Although many parents are excited to open savings accounts for kids, contributing to a child's retirement account is the real wealth builder. A Roth IRA (individual retirement account) can set your child up for financial security and teach them valuable money lessons they can use on their journey.
If you're wondering how much you should contribute to your child's Roth IRA in 2022, here are some insights to make your decision a little bit easier.
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Unlock the potential of a Roth IRA
A Roth IRA is open to children and adults of all ages. You can set aside money in a custodial Roth IRA and manage your child's account for them until they are eligible to do so.
Let's say you're able to contribute $6,000 to your child's Roth IRA once they start doing paid work and earning income at age 8. If your child's investments earn an average return of 10% and your child continues to save $6,000 in a Roth IRA during their adult years, the account could reach $1 million before your child turns 40 years old. If your child follows the withdrawal rules, they can withdraw every penny in the account 100% tax-free after they turn 59 1/2.
Your kids don't have to wait until retirement to reap the benefits of a Roth IRA. They can also use the money to pay for college expenses or buy a new home without penalties. If you want your child to have these options, start tucking away as much as possible in a Roth IRA now.
Calculate your child's earned income
Before you start contributing to your child's Roth IRA, it's important to know how much your child earned. No child or adult is allowed to contribute to a Roth IRA if they do not have earned income for the year. Also, if your child hasn't started working yet, the potential to build a million-dollar retirement portfolio may be an incentive for them to earn money and save.
Here are some popular jobs that kids usually take on:
- Acting
- Babysitting
- Dog-walking
- Modeling
- Mowing the lawn
- Tutoring
Calculate your child's total earnings from various sources. Keep records of your child's earnings so you can justify your Roth IRA contribution amount if needed. For 2022, you can contribute up to $6,000 to your child's Roth IRA if your child brought in income of at least $6,000. However, if your child only earned $2,000 for the year from babysitting and received no additional earned income, you are only able to contribute $2,000 to your child's Roth IRA.
Any dividend or interest income your child earns during the year won't count toward your earned income calculation.
Determine your 2022 contribution goal
Set a contribution goal that makes sense for your financial situation. You can always get creative with ways to reach the goal.
Let's say you aspire to contribute $6,000 to your child's Roth IRA. Maybe you decide to contribute $3,000 and help your child set up a plan to contribute the other half. That comes down to a $250 monthly contribution for both you and your child over a 12-month period.
There's no right or wrong amount to contribute. When determining your contribution goal for your child's Roth IRA, here are some questions to consider:
- How will your child use the funds in the account?
- Are you contributing money to your own retirement accounts?
- Is there a dollar amount you want your child to have in the account before they turn 18?
- Are there other savings vehicles you would like to set up for your child?
- How long will your child be eligible to contribute to a Roth IRA?
- Do you expect your child's income to skyrocket in the near future?
Take your child on the Roth IRA journey
The most important move you can make while contributing to your child's Roth IRA is to pull the curtain back on what you're doing. Show them how to set up recurring contributions, talk to them about assets you are adding to the portfolio, and explain how compounding works.
If you fail to take your kids behind the scenes of the process, you risk your contributions going down the drain when they take over the account. If possible, try not to contribute the entire amount -- leave an opportunity for your child to contribute a portion of their money to the Roth IRA, and give them a chance to learn money lessons that will last a lifetime.
