By Dave Coen
You may think Roth IRAs are only for working adults who have retirement on the brain. But think again! Roth IRAs are the unsung heroes of the investing world—and they’re an excellent savings vehicle for kids. Want to know more? Here are 4 reasons why you should consider opening a Roth IRA for your child.
1. They Can Withdraw Contributions At Any Time
Most retirement accounts charge you a steep penalty if you need to access your money before age 59½. But not Roth IRAs! You can withdraw the principal balance (aka your contributions) at any time without penalty. The growth on your money can be withdrawn without penalty after 5 years of your contribution being made.
That means you can use the Roth IRA money for your kid to save up for their first car, college tuition, a dream vacation, or whatever else they want. Obviously as a parent you want to manage any withdrawals that are made. The account will need to be set up as a custodial account for minors.
2. Compound Interest Has Decades To Work Its Magic
There isn’t a savings account out there that can beat the amount of interest your child could earn by stashing their money in a Roth IRA if we look back at historical numbers. Yes, Roth IRAs don’t offer guaranteed income, and past performance does not indicate future performance, so your child could lose their money. But history tells us a good story over a long period of time if they invest in a broadly diversified portfolio.
Let’s say your child puts $6,000 in a Roth IRA and leaves it there for 50 years. Assuming a 6% investment return, they’d have about $120k at the end of that 50-year period—and that’s without adding a single penny to their account! Wait 10 more years, and the money nearly doubles to $218k.
For reference, a $6,000 savings account balance earning 0.09% (the current national average) would only be worth $6,276.16 after 50 years. Which would you choose?
3. They Can Use The Money For More Than Just Retirement
You may be shocked to know that you can use a Roth IRA for more than just retirement. For example, once an IRA has been established for at least five years, the account holder can take out up to $10,000 for a down payment on their first home. Also, your kid can use their Roth IRA earnings for qualified education expenses, including college tuition.
4. It Won’t Impact Their College Financial Aid Eligibility
Retirement accounts aren’t reported as assets on the Free Application for Federal Student Aid (FAFSA), so your kid can keep stashing money in a Roth IRA without worrying about it affecting their financial aid. But keep in mind that if your child takes any Roth IRA distributions while they’re in college, this must be reported as income on the FAFSA application. Subsequently, it could impact their financial aid eligibility.
5. Teach Your Child About Roth IRA’s Or Roth 401K Contributions Early On
When your child starts working after college, teach them about making contributions early into their 401(k) into a Roth account or a Roth IRA while they will probably be in the lowest tax bracket they will hopefully ever be in.
What’s The Catch?
Okay, so by now you’re thinking a Roth IRA is a surefire way to help your kid save for the future. But what’s the catch? Well, here it is:
Your child must have earned income to open a Roth IRA. (1) Allowances and income from investments don’t count. If your kid earns income from mowing grass, walking dogs, or babysitting, don’t worry. This still counts as earned income. Just make sure you keep detailed records of the receipts in case you need proof of their employment down the line.
The Roth IRA contribution limit for 2020 is $6,000 or the amount equal to your child’s earned income for the year (whichever is less). (2) So, if your child made $3,000 working at the bowling alley this summer, then they can’t contribute more than $3,000 to their Roth IRA.
How We Help
There are many advantages to opening a Roth IRA for your child. Not only does it give them a head start on savings, but it teaches them valuable money lessons that most people don’t learn until much later on in life. Plus, it’s a great way to save for big-ticket items like their first car or college tuition.
At College Planning America, we’re passionate about helping families figure out what steps they can take now to lower the cost of college later on. Whether you need help understanding FAFSA or figuring out what scholarship programs are available to you, we’re here to help. Get started by emailing me at dcoen@sageviewadvisory.com or calling 800-814-8742.
About Dave
Dave Coen is a Financial Advisor with SageView Advisory and the CEO of College Planning America. Along with his retirement financial industry experience, he is a College Planning Specialist. He works closely with individuals and families to provide comprehensive financial planning that addresses all elements of their financial picture. Learn more by connecting with Dave on LinkedIn.
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This material is designed to provide accurate and authoritative information on the subjects covered. It is not however intended to provide specific legal, tax, or other professional advice. For specific personal assistance, the services of an appropriate professional should be sought. A diversified portfolio does not assure a profit or protect against loss in a declining market.
SageView Advisory Group, LLC is a Registered Investment Adviser. This report is for informational purposes only and is not a solicitation to invest. Advisory services are only offered to clients or prospective clients where SageView Advisory Group, LLC and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future results. No advice may be rendered by SageView Advisory Group, LLC unless a client service agreement is in place. CA insurance license #0G82578
Converting from a traditional IRA to a Roth IRA is a taxable event. A Roth IRA offers tax free withdrawals on taxable contributions. To qualify for the tax-free and penalty-free withdrawal or earnings, a Roth IRA must be in place for at least 5 tax years, and the distribution must take place after age 59 ½ or due to death, disability, or a first-time home purchase (up to a $10,000 lifetime maximum). Depending on state law, Roth IRA distributions may be subject to state taxes.
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(1) https://www.irs.gov/publications/p590a#en_US_2018_publink1000230355
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