Opening an IRA for your child is a great idea any time of year. Although earlier in the year provides the greatest tax planning opportunity. Anyone with earned income can open an IRA. That includes workers younger than 18. Giving a financial headstart to your children or grandchildren is a huge boost to their well-being. Here is everything you need to know about minor IRAs.
Four Benefits A Minor IRA Provides
College – having money in an IRA is helpful when you start applying for financial aid. Retirement accounts do not count as assets of the account owner. That’s helpful when you report assets on their FAFSA. A bank savings or other account type may negatively impact their financial aid application. If IRA funds are used to pay for qualified higher education expenses, the 10% early distribution tax won’t apply. Plus, contributions to a Roth IRA can be withdrawn tax and penalty-free for any reason.
Financial Education – In addition to your child having additional education funds, this can be a valuable tool for teaching your child financial lessons. These lessons can include learning how to select investments, tax implications, and traditional lessons on saving.
Use a savings calculator to help illustrate the impact saving and investing will have on their life. Adjust the variables such as monthly deposits, and interest rates to illustrate how much money they could have later in life. For example, an IRA receiving monthly $500 deposits at 10% interest could turn into $1,091,661 in 30 years.
Nest Egg – Not only will your child be financially savvier through the important lessons they learn about saving for the future, but this headstart can provide them with a significant safety net later on. Your child will have a financial safety cushion for emergencies, plus the possibility to retire early. The multi-year tax-free growth can be significant even if they stop contributing to the IRA as an adult.
First Time Home Buyer – IRA owners can withdraw up to $10,000 towards the purchase of their first home. This exemption from the 10% early distribution tax can be very helpful when your children enter adulthood. It’s also a qualified reason to withdraw tax-free investment earnings from a Roth IRA before age 59 ½.
What Counts As Earned Income For Minors?
Per IRS guidelines, earned income is any taxable income from wages. This can be work performed as an employee or even running their own business. If your child receives a 1099 or W-2 that income is eligible. Here are some ways your child can earn income:
- Mowing the neighbor’s lawn
- Working at a local restuarant
- Babysitting
- Performing work at your rental properties
- Helping you at the family business
If you own a small business or rental property these are massive tax planning opportunities!
Contributions to a Minor IRA
Similar to an adult’s IRA, the child’s IRA can receive contributions up to the annual IRS contribution guidelines. That amount is $7,000 in 2024. Additionally, a parent or anyone can contribute to the IRA on the child’s behalf. Parents or Grandparents can decide to match the amount the child deposits. However, the contributor may not take a tax deduction on their return for contributions to the child’s IRA. The child is allowed to take a deduction on their tax return.
Should I Open a Traditional IRA or Roth IRA?
You can open a Traditional IRA or a Roth IRA for minor children. If children have enough taxable income to trigger a tax liability then a Traditional IRA may be the better option. A Roth IRA can be advantageous due to the rules surrounding IRA contributions and distributions. A qualified fiduciary adviser can help you determine which route is best and help you navigate all the IRS rules.
How Do I Open A Minor IRA?
You can open a minor IRA at any custodian which allows it. Keep in mind each custodian will have their requirements and fees to maintain the account. If you’d like a list of custodians to choose from please reach out through the Contact Us.
Typically, the account is opened in the child’s name with their Social Security number. A parent or legal guardian can do this on behalf of the minor. When the child reaches the age of majority, the child will need to sign a new IRA agreement and take control of the account. A qualified adviser can make sure you fill out the paperwork correctly.
Give the gift of financial wellness to your child this year. If you are ready to take the next step, or have questions about the process, reach out to Valor Advisers through our Contact Us page.
