Give the Gift of a Roth IRA for Christmas
By Jim Glass, J.D.
IRA Analyst
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This holiday season, consider giving the gift of a big head start on lifetime financial security to the children in your family by giving them funds to contribute to Roth IRAs. There’s no lower age limit on having a Roth IRA as long as a child has earned income. And an early start on saving can have a tremendous long-term payoff through the power of compound interest.
Moreover, most children are interested in money and enjoy watching dollar amounts steadily increase in accounts in their names, even having no interest in retirement security. So your gifts that are tied to their working and saving may teach children the payoff from earning and investing, providing an educational benefit that itself proves extremely valuable over a lifetime.
Eligibility
It’s still possible to open Roth IRAs for 2017; the deadline is April 17, 2018. The contribution limit is the amount of the child’s earned income or $5,500 whichever is less. If a child is a minor (under age 18 to 21, depending on state law) open a “guardian IRA” for the child, now offered by many banks and financial institutions.
Any source of earned income creates eligibility to contribute to a Roth IRA. Lifeguarding or waiting tables will do, as will self-employment such as babysitting and mowing lawns. Pre-teens can earn income performing work such as answering phones, filing papers, and modeling for images used in marketing. A child’s earnings can come from a family business.
If a child has already spent all of his or her earned income that’s not a problem – with the earned income requirement met, contributions to Roth IRAs can be made with funds received by gift.
Rewards to Youth
The payoff to saving when so young can be immense. Stocks have earned an average 7% over inflation over the past 100 years, reports Morningstar, a rate at which amounts double every 10 years. Saving $5,500 annually from age 14 through 24 and earning 7% provides $1.06 million at age 61 on contributions of only $60,500 – saving nothing after age 24!
Starting young also makes it safer to invest for high returns. Stocks provide a high average return but can be volatile, creating risk for persons in or near retirement years. Children decades away from retiring need not fear this risk. Indeed, ‘safe’ investments can be costly for them. A safe and steady 3% return from bonds reduces the $1.06 million in our example to only $210,000.
Roth IRAs for children have other benefits as well. Contributions to a Roth IRA can be withdrawn any time for any reason, with no tax or early withdrawal penalty, creating tax-free savings available at any time. Earnings in a Roth IRA can qualify as totally tax and penalty free after age 59 1/2. In contrast, distributions from Traditional IRAs are taxable and generally subject to a 10% early withdrawal penalty before age 59 1/2. The deduction for contributions to a Traditional IRA has little or no value to a child in a very low or zero tax bracket. IRA assets also are not counted in standard college financial aid formulas, so they don’t reduce eligibly for financial aid, unlike savings in taxable accounts.
Follow up on your gift by making sure good records are kept for the children and their IRAs. Keep their income is “on the books”, reported on a parent’s or the child’s own tax return. If the child’s income comes from a family business, document that it is genuinely earned. And monitor IRA investments carefully.
Then look forward to the children you’ve helped enjoying many happy financial returns for many years to come.