If your son or daughter has a summer job, don’t forget about the Roth IRA benefits for kids. After all, summer break is here. Are your kids eagerly anticipating their first job or internship this summer? For women facing new beginnings, especially those navigating changes such as starting over after a divorce, losing a spouse, or facing an empty nest, this can be an opportune moment to set the stage for a brighter financial future for you and your children. One of the best ways to do this is by opening a Roth IRA for your child.
Earning a first paycheck is exciting. It also represents an excellent time to consider opening a Roth IRA to take advantage of the Roth IRA Benefits for Kids. Contributing a portion of their summer earnings can provide your kids with lifelong benefits. First, it jump-starts their retirement savings from an early age. Second, it can provide a positive learning experience reinforcing the importance of saving, investing, and cultivating long-term wealth.
An Example
One of my sons opted for a co-op in the spring semester of his junior year of college. Yes, he will graduate a semester later than planned. But that’s okay. The co-op was extended to a summer internship. Through conversations we had after he started working, he is realizing Roth IRA Benefits for Kids first-hand. Every time he gets paid, he transfers some of his earnings to his Roth IRA and some to his taxable brokerage account.
We figured out how much money he will need when he returns to school this fall. That way he won’t have to work. He can focus on his schoolwork and have some time for fun, too.
Why did we decide to save money in two different types of accounts? First, he can access money held in a regular brokerage account more easily than funds in a Roth IRA. Second, Roth IRAs offer a unique combination of tax advantages and flexibility, making them an excellent choice for young savers.
What is a Roth IRA?
As a reminder, a Roth IRA (Individual Retirement Account) is a type of retirement savings account offering tax-free growth and tax-free withdrawals in retirement. Contributions to a Roth IRA are made with after-tax dollars, meaning the money has already been taxed before it is deposited into the account. While there is no immediate tax benefit, the advantage comes later: the earnings on your investments grow tax-free, and qualified withdrawals in retirement are also tax-free.
Some of the Roth IRA Benefits for Kids
- Tax-Free Growth: Since your child is likely in a low tax bracket today, paying taxes on their contributions upfront does not represent a significant burden. They get many years of tax-free growth. The power of compounding can make this growth quite substantial. Assume your 20-year-old saves $5,000 in a Roth IRA today. Let’s see how much they might have in 40 years based on different annualized growth rates:
| Amount Deposited | Annualized Growth Rate | Future Value |
| $5,000 | 5% | $35,199.94 |
| $5,000 | 6% | $51,428.59 |
| $5,000 | 7% | $74,872.29 |
| $5,000 | 8% | $108,622.61 |
| $5,000 | 9% | $157,047.10 |
| $5,000 | 10% | $226,296.28 |
Note that 40 years was used because you don’t pay taxes on the growth in your Roth IRA after age 59 ½. Depending on how much your child earns this year, they may not pay any taxes on the original deposit. At most, they will likely pay no more than 12% federal taxes on those earnings. That means those savings can generate significant tax-free growth. Tax-free growth is a huge benefit. Your child will realize even greater benefits if they can do this for a few years. In short, Roth IRA Benefits for Kids can add up.
- Penalty-Free Withdrawals of Contributions at Any Time: Your child can withdraw up to the amount of their total contributions at any time, for any reason, without paying taxes or penalties.
- Time Is on Their Side: The earlier you start investing, the more time your money has to grow. By opening a Roth IRA for your child now, you’re giving them a head start on their retirement savings. As shown in the table, even small contributions can grow significantly over several decades. This represents a great example of how time in the market can matter much more than timing the market.
- Encourages Good Financial Habits: Opening a Roth IRA can be an excellent way to help your child appreciate the importance of saving and investing for the future. It can also provide a practical lesson in understanding the stock market, interest rates, and the impact of taxes.
Empowering a New Financial Legacy
For women facing new beginnings, instilling financial literacy and independence in their children can be a powerful step forward. Involving your children in financial planning early can help them secure their future. It can also help them build a legacy of financial responsibility and empowerment.
Some Things to Watch Out For
- Early Withdrawal of Earnings: If your child withdraws amounts that exceed their contributions before age 59 ½ and before the account has been open for five years, they may owe taxes and a 10% early withdrawal penalty on the earnings portion of the withdrawal.
- Exceptions to Early Withdrawal Penalties: Your child can withdraw funds before age 59 ½ or before the account has been open for five years for several reasons (keep in mind that you may be able to avoid penalties but not taxes on any earnings), including:
- Funds can be used for qualified higher education expenses.
- First-time home purchases (up to a $10,000-lifetime limit.)
- If your child becomes disabled.
- For certain emergency expenses.
- If your child is unemployed, they can use a withdrawal to help pay for health insurance premiums.
Other Considerations
The flexibility and withdrawal choices for a Roth IRA can make it an attractive choice for young savers who may need access to their money in the future while still providing a powerful tool for long-term wealth building.
Keep in mind that for a Roth IRA to qualify for the tax- and penalty-free withdrawal of earnings, Roth IRA distributions must meet a five-year holding requirement and occur after age 59 ½. Tax-free and penalty-free withdrawals can also be made under certain other circumstances, such as in the examples we listed above. The original Roth IRA owner is not required to take minimum annual withdrawals. Future heirs do not have to take required minimum distributions either.
Eligibility Requirements
To contribute to a Roth IRA, your child must have earned income from a job, and the maximum contribution for 2024 is $7,000 or the total of their earned income, whichever is less. You can open and manage the account until they reach the age of majority in your state (typically 18 or 21).
Steps to Open a Roth IRA for Your Child
- Choose a Custodian: If your child is under 18, you must open a custodial Roth IRA. Many financial institutions offer these accounts, so shop around for one with low fees and a variety of investment options.
- Fund the Account: Once the account is open, you can help your child deposit their earned income into the Roth IRA. Remember, the contribution cannot exceed their total earned income for the year.
- Select Investments: Help your child choose appropriate investments for their Roth IRA. A diversified portfolio of low-cost index funds can be a good starting point.
- Monitor and Adjust: Regularly review the account’s performance with your child. This is a great opportunity to teach them about market fluctuations and the importance of a long-term investment strategy.
If your child needs the money and you can afford it, consider funding the account for your child. You can give them a gift and contribute it to their Roth IRA. Just remember that their contribution can’t exceed their earned income for the year of $7,000, whichever is less.
Benefits Beyond Retirement
While the primary purpose of a Roth IRA is to save for retirement, it offers other benefits as well. You can use Roth IRAs to pay for qualified education expenses, making them a flexible tool for future financial needs. Additionally, you can withdraw Roth IRA contributions (but not earnings) at any time without penalty, providing a potential source of funds in case of emergency.
One More Thing: They May Need Help Filling Out Their Form W-4
If your child makes less than $14,600 in 2024, they may want to claim an exemption from withholding on their W-4 form by writing “Exempt” on line 4(c) of the form.
Here’s Why:
- Standard Deduction: For the 2024 tax year, the standard deduction for a single filer is $14,600. If your child’s total income for the year is less than this amount, they won’t owe any federal income tax.
- Claiming Exemption: If your child expects to owe no federal income tax for the year and wants to have no tax withheld from their paycheck, they can write “Exempt” on line 4(c) of Form W-4. This means the employer won’t withhold any federal income tax from their paychecks.
- Remember that if your child claims an exemption, Social Security and Medicare taxes may still be withheld from paychecks. Also, if their situation changes and they owe federal income tax for the year, they may face underpayment penalties.
- Our ideas in this letter are for informational purposes only and are not a replacement for real-life advice. Consider consulting your tax, legal, and accounting professionals if you have questions about completing Form W-4.
Closing Thoughts About Roth IRA Benefits for Kids
Opening a Roth IRA for your child’s summer job or internship earnings is a powerful way to set them on the path to financial success. It leverages the benefits of tax-free growth, teaches important financial skills, and provides flexibility for future needs. For women facing new beginnings, this strategy not only helps your child save for retirement but also instills valuable lessons that will benefit them throughout their lives.
Investing in your child’s future is one of the best gifts you can give, and the Roth IRA Benefits for Kids make a Roth IRA a fantastic place to start.
If you’d like to discuss opening a Roth IRA for your child or grandchild, feel free to contact us. Please feel free to share this with anyone you think might be interested as well.
Wishing you and your family a wonderful start to the summer.
Our practice continues to benefit from referrals from our clients and friends. Thank you for your trust and confidence.
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For firm disclosures, see here: https://apprisewealth.com/disclosures/
Phil Weiss founded Apprise Wealth Management. He started his financial services career in 1987 working as a tax professional for Deloitte & Touche. For the past 25+ years, he has worked extensively in the areas of financial planning and investment management. Phil is both a CFA charterholder and a CPA.
Located just north of Baltimore, Apprise works with clients face-to-face locally and can also work virtually regardless of location.
