Many children work before they reach age 18. The income they earn makes them eligible to contribute to a Roth IRA, which can be an extremely smart move for teenagers. Yet financial institutions typically can't let minor children open a Roth IRA on their own. Fortunately, many institutions will let parents act as a custodian on a custodial Roth IRA for the benefit of their children. Let's look at some of the rules involved.
Typical rules for Roth IRAs
To be eligible to open a custodial Roth IRA, the child must meet all the same requirements as an adult would. The minor must have earned income, and contributions are limited to the lesser of total earned income for the year and the current maximum set by law, which for 2015 and 2016 is $5,500.
Also, adjusted gross income for the child must be below the thresholds above which Roth IRAs aren't allowed. In 2016, eligibility to contribute to a Roth IRA for single filers in 2016 starts to phase out at $117,000 and completely phases out at $132,000.
Special custodial Roth IRA rules
In addition to the typical rules, custodial Roth IRAs involve some additional restrictions. Even though the custodian is the legal owner of the account, the Roth IRA must be managed for the benefit of the minor child. The custodian therefore can't commingle money from his or her own retirement accounts, and any withdrawals must be used for the minor child's benefit rather than the custodian's own personal gain. The custodian also can't take the money back at a later date.
When the minor child reaches the age of majority, which is typically 18, then the custodial Roth IRA becomes an ordinary Roth IRA. The child can then make transactions on the account unilaterally. Parents must therefore be comfortable that the child will honor the intent of setting up a Roth IRA rather than simply taking the money out when turning 18.
Finally, bear in mind that because it's unusual for minor children to have retirement accounts, some financial institutions won't necessarily have the resources in place to handle a custodial Roth IRA without special effort. Waiting until the last minute to try to set up a custodial Roth IRA is a bad idea, and it's smart to contract your financial institution early to make sure they have any necessary paperwork and procedures in place.
Despite the additional work involved, helping your child set up a custodial Roth IRA can be a great way to get an early start on retirement saving. It can also teach children more about financial matters generally, helping them get investing experience that will help them throughout their lives.
If you (or your kids!) want to learn more about the ins and outs of IRAs, head over to the Fool's IRA Center. We can help you figure out what options are best for you and your family.
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