Providing your child with a solid financial foundation is one of the best gifts you can offer. While it’s tempting to open a savings account and call it a day, a Roth IRA could take your child’s financial future to the next level.

However, if you’re wondering if this is a good time to set up a custodial Roth IRA for your child, we’ve jotted down a few things to keep in mind.

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How a custodial Roth IRA works

A Roth IRA is a tax-advantaged account that comes with many benefits, such as tax-free income during retirement and the ability to withdraw funds for college expenses without penalties.

Unlike many financial tools that come with age restrictions, the Roth IRA is available to individuals of any age as long as they meet the income requirements. This makes it possible for your young child, such as an 8-year year old working in a family business, to have a Roth IRA if you open one on their behalf.

Typically, brokerage firms will require an adult to oversee and manage the account, which is commonly known as a custodial Roth IRA. In this setup, your child is designated as the beneficiary of the account, while you handle the contributions and investment decisions until your child reaches a certain age — usually 18, though this can differ depending on where you live.

If you’re thinking about opening a Roth IRA for your kids, it’s important to get them involved in the process early on. You can turn saving and investing into a fun and educational activity by matching their contributions and helping them log into the account to witness the power of compound interest firsthand. That way, they’re more likely to manage their funds wisely when they eventually take control of the account.

Make sure your child qualifies

Your child must have earned income in order for you to contribute to a custodial IRA on their behalf. A kid can earn money in a variety of ways, including:

• Mowing lawns
• Shoveling snow
• Babysitting
• Dog walking
• Modeling
• Bagging groceries
• Acting
• Tutoring
• Assisting with social media management
• Working in retail

Keep in mind that money your child earns from dividend, interest, or other sources of passive income won’t count toward the earned income calculation.

If your child has self-employed income instead of W-2 income, you might want to work with a qualified tax professional to make sure you’re sticking to the rules. Keep good records that show the nature of the work performed, dates of service, earnings, and clients serviced so you can confirm your child’s eligibility to contribute to a Roth IRA if needed.

A few items to consider

By setting up a Roth IRA for your child now, you can put them on the path to becoming a millionaire. Consistent contributions and smart investment choices can move them toward this goal. Also, if your child needs to access funds before retirement, they can withdraw contributions made to the account at any time without facing taxes or penalties.

However, there are a few limits and considerations you need to be aware of:

• Your child’s income must be below a certain threshold to contribute to a Roth IRA.
• You can contribute up to 100% of your child’s earned income to the Roth IRA, with a maximum limit of $7,000 for 2024.
• Your child can use the money in the account however they wish once they gain control over it.
• Withdrawals from the Roth IRA during college could impact your child’s eligibility for financial aid.

Determine if the benefits outweigh the limits

It’s a good idea to sit down with your child and start discussing goals and finances now. Even if a Roth IRA does not fit into your current financial plan, introducing your child to the concepts of saving and investing can produce dividends later. A few thousands dollars today can easily turn into a six-figure portfolio over time if your child consistently contributes and earns a decent return. Additionally, the habits they develop now could give them a head start in planning for their dream retirement.

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