IRAs (individual retirement accounts) are fantastic investments for people of all ages, and many adults regret not starting on theirs sooner. There are so many benefits, and the sooner you start growing your money, the more financially set you'll be in the future. So, can you open an IRA for a minor to set them up for financial success?
One way to ensure your child is set up for success later in life is to open an IRA for them. An IRA, or Individual Retirement Account, is a savings account that allows you to set aside money for retirement. Contributions to an IRA are tax-deductible, and the earnings grow tax-deferred. This means that your child can add money to their IRA now and let it grow over time. When they reach retirement age, they will have a nest egg to draw from.
You can open an IRA for a minor and serve as the child's custodian until they are 18. As with adult IRAs, a maximum of $6,000 is contributable per year or the total of the child's yearly income, whichever is lowest. A child must earn their own money to contribute to an IRA and track that income.
In the rest of this article, I will discuss the benefits of starting an IRA for a minor, the best types of IRA for kids, and the steps for opening one for your child. So if you want to learn more about utilizing an IRA for minors, keep reading.
Benefits of Starting an IRA for a Minor
As I previously stated, many people regret not getting started saving and investing their money through an IRA. It's essential to think of your future at a young age, especially with inflation making your savings less valuable when it comes time for you to retire. However, no matter your age, having an IRA is extremely valuable.
The sooner you start contributing, the more money you will have in your account when you retire. Additionally, the money in your IRA will be worth more due to compounding interest. Even if you are close to retirement age, it is still beneficial to open an IRA and start contributing to it.
Some of the benefits of starting an IRA for a minor:
- Grows tax-free money if in a Roth IRA. Tax-free money means when the child finally withdraws the money from the account, they won't have to pay income tax on the money.
- Allows minors to get a leg up on savings. The world is ever-changing, and having a healthy nest egg right out of the gate can improve your child's feeling of safety as they transition to adulthood.
- Creates financial literacy. Finances can be hard to understand, and the sooner your child starts learning about how to grow and make money, the better off they will be.
- Funds educational endeavors. With an IRA, you can draw some money early for legitimate purposes like education. So, when your child reaches college age, they can use the funds towards a part of education expenses.
- Bankrolls purchasing a home. Another way your minor can withdraw the money from their IRA is if they wish to purchase a home. Buying a house is expensive, and owning property is a great starting place for any adult.
- Funds are available for emergencies. So if your minor has a significant emergency and needs cash, they can withdraw some funds tax-free to help.
When it comes to saving for retirement, it's never too early to start learning about money management and the importance of saving.. As you can see, there are several benefits to opening this kind of savings account for your minor. First, children are often focused on the now and will thank you when they reach adulthood and don't have to worry about creating enough wealth.
The Best IRAs for Minors
Setting up an IRA for your minor is relatively simple. However, you must first choose which IRA type fits your child's future financial needs. There are two main types of IRA accounts to choose from; though they are pretty similar, there are a few key differences to consider before opening your child's IRA.
Both have advantages, so it is essential to consider which fits your child's future needs. You can open an account with most banks or financial institutions. When adding your child as the account holder, be sure to ask about any management fees that may be associated with the account. It is also essential to consider how much you will be able to contribute each year. The IRS sets yearly contribution limits, and these limits increase as you get older.
First, there is the traditional IRA account. With a traditional IRA, you pay income taxes once the money is withdrawn for retirement rather than when it goes in. This savings account works well for those who don't see themselves in higher tax brackets when the money is withdrawn, or those who don’t plan on withdrawing the money until after they’re retired.
A traditional IRA can also be great for families that make more money since there are no rules about how much money you can make to open one. Also, a traditional IRA requires you to start withdrawing the money by 72.
Like with Roth IRAs, you can only contribute up to $6,000 per year, or $7,000 if you're over 50. What you place into your Traditional IRA cannot exceed your annual income. On the downside, there are often penalties for withdrawing your funds early.
Then, there is the Roth IRA. This form of IRA is an excellent option if you don't want to worry about paying taxes on your money's growth. Additionally, the money is withdrawable without penalty for essential things like home purchases, education, or emergencies.
It's important to note that any money in your Roth must be income you have paid taxes on. Another thing that makes Roth IRAs great is limited penalties for withdrawing the funds early.
The funds of your IRA will be available for withdrawal after you reach 59 ½ years of age. However, the money can be left longer to grow if you wish since there are no mandatory withdrawals. Additionally, after you reach 50, your yearly contributions can increase from $6,000 annually to $7,000 (as of 2022).
Convincing a Minor To Invest in Their Future Through an IRA
When it comes to getting your child excited about investing money for their future, there are a few critical steps you'll need to take. First, it's important to give them a overview of how an IRA works and what type of form it requires. Adding funds to an IRA is often required for those who want to achieve financial stability later in life, so it's essential that your child understands this key concept.
Additionally, you'll need to help them understand that an IRA is an individual account that must be managed carefully. By taking the time to explain these key points, you can set your child up for success as they begin to invest in their future.
It's also important to note that parents cannot simply pay children insane amounts of money to do menial jobs around the home. For example, if a parent pays a child to complete a task like mowing the lawn or walking the dog, it must be the going rate for that job in the area. Also, a detailed record of the child's income needs to be kept for taxing and investment purposes.
As for convincing your minor that this account is essential, letting them know that the money will help cover college, a home, and retirement is a great place to start. You can make saving fun by showing your child how much their money has grown and getting them excited about their bright future.
Money Making Ideas for Minors IRAs
There is no age limit for how early you can open an IRA for your minor. So, your child can start contributing to their account at a very young age. An ideal way to prove your minor's income is through a 1099 or W2. However, for young kids, this kind of work usually isn't feasible until they are at least 16 years of age.
So, until they reach working age, your child can do other things for income to invest in their IRA. However, a detailed record of the job, the date, time, and the amount they were paid is vital. Detailed work records are essential to ensure no problems arise with the money they invest.
Additionally, allowance money does not count as income unless each task is broken down and paid as the going rate for someone else to do that job.
A few ideas for minors to make money for their IRA:
- Pet sitting.
- Dog walking.
- Dog waste cleanup.
- Mowing lawns.
- Pulling weeds.
- Lemonade stands.
Surprisingly, there are many ways for young kids to generate funds to invest in their IRA. With a little creativity, young kids can easily get involved in saving for retirement. The most important thing is to make it enjoyable so that the child will form positive habits that will last a lifetime.
How To Open an IRA for a Minor
Surprisingly, the process for opening an IRA for a minor is simple. You can open an account for your child in as little as 10 minutes. The hardest part of opening an account is figuring out which company to open the IRA with. However, a few form overviews available online can help you compare companies and make a decision.
Steps for opening an IRA for a minor:
- Select the type of IRA you want to go with, either Roth or Traditional.
- Choose a company to open an account with, like Fidelity or Vanguard to invest in stocks and bonds
- Choose a company like MyDirect IRA to invest in things like real estate and crypto.
- Select open an IRA for kids on the company's website.
- Create a login and fill out personal info like the child's name, birthday, and social security number.
Once you have completed the registration process and linked the IRA to a bank account, the account is ready to receive funds. Once the funds have arrived, you can start investing and growing those funds for your minor.
What Is the Minimum Age for a Roth IRA?
The minimum age for opening a Roth IRA is 18. However, an account can be opened for an infant if an adult is there to open the account and act as the custodian. As the custodian, the parent is responsible for depositing funds and selecting where to invest those funds until the minor is an adult.
Can I Pay My Child a Salary?
You can pay your child a salary; however, you must be able to prove the child is doing the job to earn that income. In addition, a detailed record needs to be kept to ensure there are no future problems with their IRA. When it comes to paying your child a salary, you'll need to add them as an employee to your business and follow all of the required tax withholdings. You'll also need to ensure that any contributions you make to their IRA are made through an individual account - rather than a family account.
Can You Contribute to Both Roth and Traditional IRA For a Minor?
You can contribute to both a Roth and Traditional IRA for a minor so long as you qualify for both account types. However, each account cannot exceed $6,000 ($7,000 over 50) deposited yearly. Remember, a Roth has tax-free growth, and a Traditional will be taxed upon withdrawal. Both have their advantages, so it's important to understand the difference before making any contributions.
Opening an IRA for a minor is a great way to set a child up for success. There is no age limit on how early you can open an account and start investing. However, you must add the required documentation proving the child made the income to deposit it and start investing. The earlier you start, the more time the child's investments have to grow. Some advantages to opening an IRA for a minor are that some banks and credit unions will waive fees for children's accounts, and there are usually no taxes on the contributions. Another advantage is that the money in the account belongs to the child, even if the account is in the parent's name. This can be helpful if the family goes through a divorce or bankruptcy. If you're considering opening an IRA for a child, talk to a financial advisor to find out what options are best for you.