Laura answers a listener's question about starting a Roth IRA for teenage children who work part-time jobs.
Laura answers a listener's question about starting a Roth IRA for teenage children who work part-time jobs.
Money Girl is hosted by Laura Adams. A transcript is available at Simplecast.
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Welcome back to Finance Friday, another special edition of Money Girl, where I answer your burning money questions! Today's topic comes from Marietta, who says, "I have teenage children who work part-time jobs. Can I start a Roth IRA for them?"
Thanks for your question, Marietta! You're very wise to be thinking about helping your kids invest for their futures with Roth IRAs. This post will review legitimate ways minors can have a retirement account and take advantage of a Roth's terrific tax-savings benefits.
Welcome back, everyone, and thanks for joining me. I'm Laura Adams, an award-winning author, finance spokesperson, money speaker, founder of The Money Stack newsletter, and host of the Money Girl podcast with 43 million downloads. My mission is to help you get the knowledge and motivation to prioritize your finances, build wealth, and have more security and less stress.
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If you have a question you'd like me to cover, please leave it on our voicemail line at 302-364-0308. You can send an email and sign up for the free Money Stack newsletter at LauraDAdams.com.
What is a Roth IRA?
If you've been a Money Girl podcast listener or have read any of my books, you probably know that a Roth IRA is an individual retirement account. It requires you to make nondeductible, after-tax contributions–but its tax benefits come in retirement when you can take tax-free withdrawals.
If you follow some simple rules, your kids could have massive investment growth in a Roth IRA and skip paying taxes on all of it. Those tax savings could be huge, depending on the account earnings.
Another Roth IRA benefit is that you can withdraw your original after-tax contributions at any time penalty-free because they were previously taxed. That allows you or your kids to tap a Roth IRA early for future expenses, like college or a car.
Of course, I recommend staying out of your or your child's retirement account so it grows undisturbed and builds as much wealth as possible. But it's nice to have the option for penalty-free withdrawals, and that fact may make it easier to contribute funds to an IRA.
However, taking earnings from a Roth IRA before age 59.5 means they would be subject to income tax and an additional 10% penalty. But if you've owned a Roth IRA for at least five years and are over 59.5, all withdrawals are tax-free, which is fantastic.
Another Roth benefit is that, unlike traditional retirement accounts, they have no required minimum distributions (RMDs) at any age. Therefore, you, not the IRS, control when and how much to take from your retirement account. You can take tax-free money from a Roth as needed or let it grow tax-free indefinitely for you or your heirs.
For 2024, the maximum IRA contribution is the account owner's earned income, up to $7,000 or $8,000 if you're over 50. For example, if a minor child earns $10,000, they (or their parents) can contribute up to $7,000 to an IRA.
However, if a child only has $2,000 in earned income for the year, they could only contribute $2,000 to a Roth IRA. You can make IRA contributions up to your tax filing deadline for the prior year.
There's no minimum income or age for kids to qualify for an IRA. However, they must have legitimately earned income from employment or self-employment, and I'll cover more about that in a moment.
RELATED: How many Roth accounts can I have?
What income qualifies for a Roth IRA?
For an IRA, qualifying income must come from working, such as wages, salaries, commissions, and tips reported in box 1 of Form W-2, Wage and Tax Statement. The following are examples of income that does not qualify kids or adults for IRA contributions:
Since an IRA requires earned income, it's not likely that very young children could qualify for one. But it's common for pre-teens and teenagers with W-2 after-school or summer jobs to contribute to or max out a Roth IRA.
SEE ALSO: 10 IRA Facts Everyone Should Know
Does business income qualify for a Roth IRA?
Kids also qualify for an IRA if they have net earnings from their own business, like babysitting, tutoring, or dog walking. But you can't pay a child a large cash allowance for household chores and call it income for IRA purposes without documenting and claiming it as real business income.
If a child works in a family business, you should treat them as an employee by deducting income taxes from their pay and issuing a W-2 to ensure they can have a Roth IRA. If a child does legitimate, age-appropriate work for a reasonable wage, that qualifies them for an IRA.
Even if a minor earns less than the standard deduction and doesn't owe any income taxes, it's wise for a parent to submit a tax return on their behalf. That ensures you document their earnings with the IRS so they can't question the legitimacy of any Roth IRA contributions.
Plus, a child may qualify for a tax refund of withheld earnings. You must file a tax return to trigger a refund payment from the government in the following year.
Minors with self-employment income must file a tax return when their net earnings exceed $400. If you're unsure whether your child should file a tax return or you have questions about paying them in a family business, or setting them up with a Roth IRA, get advice from a certified tax professional.
ALSO READ: 10 Things Every First-Time Investor Should Know
How can parents help kids contribute to a Roth IRA?
Opening a Roth IRA for a minor at most banks, brokerages, and investment firms is easy. You might choose an online robo investing platform like Betterment. The account will be in your child's name, but you must manage it until your child turns 18 or 21, depending on your home state.
It doesn't matter where a child's IRA contributions come from, such as a parent's bank account, as long as the child is eligible for them. A parent could let their kids keep all their earned money and make IRA contributions on their behalf.
You might even create an incentive where you match the amount a child contributes to their IRA, assuming you stay within the current $7,000 limit. The source of the funds could come from parents, grandparents, or other family members.
Starting an IRA early in life means your child has lots of time for it to grow into a significant nest egg, even with modest contributions. Imagine you help your child contribute $500 to a Roth IRA every year from age 10 to 20. Even if they never contributed to the account again, it would grow to about $250,000 by their 65th birthday with an 8% average return.
But if your child contributed $1,000 a year starting at age 20, they would have more than $600,000 in the account. And by contributing $5,000 a year, the account value would mushroom to over $2 million in their mid-60s!
With some foresight, you can put your kids on very successful paths and even raise millionaires by showing them how small, regular investments are the secret to creating wealth and financial independence.
LISTEN ALSO: 8 robo platform benefits investors should know
That's all for now. I'll talk to you soon. Until then, here's to living a richer life!
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