With the kickoff to the holiday giving season upon us, many clients may be wondering how they can use this opportunity to give a gift that helps children and grandchildren start out on the right foot financially.
While savings bonds, Section 529 plan contributions and outright cash gifts are popular options, one often-overlooked tool for helping the younger generation begin their savings program is the Roth IRA. For clients looking for a flexible, tax-preferred option for helping their children or grandchildren begin to save for the future, the Kiddie Roth IRA can offer both flexibility and a powerful option for tax-free growth because of the significant amount of time that the funds could potentially be left to grow. Despite this, understanding the IRS rules for when and how these accounts can be established is key to maintaining the tax benefits of a Roth IRA for younger generations this holiday season.
Basics for Establishing the Kiddie Roth IRA
Many clients overlook the Kiddie Roth IRA option for minor children because they believe there are age limits that prohibit contributions for minors—in fact, until an individual reaches age 70½, the only restriction on funding even a traditional IRA is that the individual have earned income for the year. In 2019, an individual may contribute the lesser of (1) his or her earned income for the year or (2) $6,000.
Therefore, if a minor child had a summer or part-time job that generates earned income, that child is eligible to open and contribute to a Kiddie Roth IRA. The Kiddie Roth IRA is technically established by a minor child’s parent (or grandparent) as a custodial account, with the adult acting as custodian and the minor as the account holder—once the funds are transferred into the child’s account, the transfer is irrevocable (i.e., the funds cannot later be transferred into an account for another individual). Once the child is no longer a minor, the funds become his or hers to control.
As long as the child has earned income, it doesn’t matter where the funds that are actually contributed to the account come from—meaning that if the child earned $6,000 in 2019, a parent or grandparent can fund the Kiddie Roth IRA for that child with $6,000 of the adult’s own money, allowing the child to keep his or her income. Earned income is any taxable income earned by the child, including traditional W-2 wages from a summer job or even self-employment income earned mowing lawns or babysitting.