We all want to give our kids the best possible start in life, and we all worry about what the future holds for them. Many parents choose to invest in a college savings account to help their children with their education costs, but that's not even the largest expense they'll face in their lifetime. Retirement can cost millions, and many workers struggle to save enough during their careers.
There are ways you can help your child with this if you have the extra cash or if you have a teen who's working and wants to set aside some of their own funds. Here are three ideas you can try.
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1. Custodial IRA
A custodial IRA is essentially the same as an IRA for adults. The child's name goes on the account, and they're considered the owner, but the parent or guardian must open the account on the child's behalf. This account can be either traditional or Roth. However, Roth IRAs may make more sense for young workers with low salaries. They'll only pay a small percentage in taxes upfront right now, and then they'll be able to withdraw the money tax-free in retirement.
To contribute to a custodial IRA, the child must earn income during the year. This could be a teen working a traditional after-school job or even doing something like mowing lawns for neighbors on the weekend. As long as it's income they report to the IRS, it counts.
Custodial IRAs have the same contribution limits as regular IRAs. In 2024, you're allowed up to $7,000, or the maximum income the child earned during the year, whichever is less. The child may elect to defer some of their own earnings, or you can put in your own money. The IRS doesn't care who funds the account as long as the total doesn't exceed the annual limits.
You can open a custodial IRA with many popular brokers. It's similar to opening a regular IRA. You'll need to provide information about yourself and your child, and you may need some cash on hand to make an initial deposit. You'll have to choose what to invest in as well, but you can change your mind about this later.
2. Custodial brokerage account
It's possible to open a brokerage account for a child if you're looking for something a little more flexible. These accounts don't offer the same tax benefits as custodial IRAs, but they also have fewer limitations. You or your child can contribute as much as you'd like to these accounts regardless of their income, and you can withdraw the money at any time without worrying about penalties.
That said, you will still owe taxes on your contributions in the year you make them and your earnings when you withdraw the money. You could also face gift taxes if you contribute too much of your own money to the account in a given year. And because these funds are considered your child's assets, it could affect their financial aid eligibility.
There are two main types of custodial brokerage accounts:
- Uniform Gift to Minors Act (UGMA) account: This enables your child to invest in securities like stocks, bonds, and mutual funds.
- Uniform Transfers to Minors Act (UTMA) account: In addition to securities, this enables your child to invest in things like art, patents, and real estate.
UGMA accounts are available in every state, and UTMA accounts are available in all states except South Carolina and Vermont.
If you're interested in one of these, it's best to compare some of the best custodial accounts before selecting one. Look at their fees and investment options, so you know what you're getting.
3. 529 account
529 accounts are intended to help your child pay for higher education costs, but a new rule means leftover funds could also kick-start their retirement savings. Beginning on Jan. 1, the government now permits 529 account holders to roll over up to $35,000 in unused funds to a Roth IRA in their own name over their lifetime.
There are rules your child must know if planning one of these transfers, including:
- The 529 account must be open for at least 15 years before doing a 529-to-Roth IRA transfer.
- The Roth IRA must be in the name of the 529 account beneficiary.
- Funds deposited in the five years before you begin making distributions and any associated earnings aren't eligible for the rollover.
- You can only contribute up to the lesser of the annual Roth IRA contribution limit ($7,000 in 2024) or your actual income during the year.
- The money you roll over reduces how much you can contribute directly to an IRA that year. For example, rolling the full $7,000 over in 2024 would render you ineligible to make any additional IRA contributions this year.
This is still a relatively new rule change, so there are some details the IRS still hasn't clarified yet. For example, it's unclear whether changing 529 beneficiaries at some point resets the 15-year clock. Hopefully, the IRS will issue additional guidance on this new transfer option soon to help you decide whether this is the right approach for you.
It's also possible to use a combination of the strategies above if you prefer. You might want to ask your child to weigh in on what they think is best if they're old enough to understand. And it's fine to make a plan for now and change your mind later. You can always switch to a different account down the road.
