Traditional & Roth IRA for Kids: Potential Benefits of Starting Early

Parents want what’s best for their kids. It’s why they tell kids to brush their teeth, assign them chores, and sign them up for character-building extracurricular activities.

When it comes to money, parents also want their kids to tread on the right path. They might talk about the importance of saving up for major purchases or for college. They may offer them allowances to help them learn to manage money on their own. They may even buy games related to finance to give kids a sense of how cash flows.

But parents often fall short when it comes to helping their children understand the more complex topic of building wealth for the long term through investing.

It’s important to have the conversation about saving for retirement, especially by the time your child has a summer or high school job. A traditional or Roth individual retirement account (IRA) for a child can be a great tool to help them see the impact of saving and investing for retirement, and with IRAs of their own, children can see firsthand how these retirement accounts work.

How can I open a Roth IRA for a child?

An IRA can be a good way to help children start saving for retirement with their first job and teach them how savings habits can payoff through the power of compounding.

The difference between a traditional and Roth IRA for a child is the same as the difference between those two tax-advantaged retirement accounts for an adult. Traditional IRAs allow the account owners to make deposits up to a certain amount and then count that amount toward a tax deduction. Any withdrawals taken from a traditional IRA are subject to taxes.

For Roth IRAs, the tax advantage comes later. When you make these deposits, the funds are already taxed as income. Then, when you withdraw those funds, you will not have to pay taxes on any gains your investments made. Many minors, such as those who hold part-time or summer-only jobs, have annual incomes that fall below the taxable threshold. In such cases, contributions to a Roth IRA and distributions have the potential to be tax free.

To open a traditional or Roth IRA for minors, you’ll need to open it in your child’s name and manage the account as a custodian. Then, when your child reaches the age of majority in your state, whether that’s 18 or 21, your child takes over the management of the IRA.

If you already have an investment account, check to see if your broker offers a traditional or Roth IRA for kids. Because the account is in your child’s name, you’ll need their tax identification number, which is usually their Social Security number. Keep your own information, including your Social Security number, handy just in case you need it.

Traditional & Roth IRA for kids: It’s never too early    

There’s no age restriction on a traditional or Roth IRA for kids. If your five-year-old child has earned income, you could conceivably open an IRA in their name and start the retirement saving process.

The earlier children start investing, the more time their investments have to potentially take advantage of the power of compounding. 

Like with any IRA, an IRA for a minor comes with contribution caps. For the 2023 tax year, you can add $6,500 per year to an IRA, but you won’t be able to put that much into an IRA for your child if they don’t earn above that threshold. For example, if your kid makes $3,000 as a lifeguard over the summer and doesn’t make any other money during the year, what they earned, $3,000 in this case, is the limit.

Earned income, for the purposes of a traditional or Roth IRA for kids, includes money from any job they’d report on a tax return. Self-employment, like mowing lawns and babysitting, counts as earned income. Your child can also work doing small tasks for your family business if you pay them a reasonable wage.

You and your child can both make contributions, but your combined annual contributions can’t exceed either the child’s total earned income or $6,500, whichever is lower.

One strategy is to offer a match. Tell your kids that if they put in money from their jobs, you’ll match with your own money. This encourages them to take an interest in their future and how their investments are doing.

What are some investment lessons with a traditional or Roth IRA for a child?

A traditional or Roth IRA for minors can be one way to help your child pursue long-term wealth by offering a number of savings and investment lessons. As you and your child contribute to the account, make sure to share and discuss its performance.

As your child’s portfolio develops, you can help them identify successful investment choices versus less successful choices. This is an opportunity to discuss why a particular stock increased or decreased, and what lessons they can learn in hindsight from how their portfolio performed.

Watching the account over time and engaging in discussions about it can help your child remain excited about retirement investing. Kids who catch the “investing bug” at an early age may be more likely to continue contributing once they’re managing their retirement nest eggs on their own.

TD Ameritrade does not provide tax advice. We suggest you consult with a tax-planning professional with regard to your personal circumstances.