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Quick Tips: Roth-IRAs for Children

July 19, 2013 by Brad 4 Comments  Richmond Savers has partnered with CardRatings for our coverage of credit card products. Richmond Savers and CardRatings may receive a commission from card issuers.

Opinions, reviews, analyses & recommendations are the author’s alone, and have not been reviewed, endorsed or approved by any of these entities. Disclosures.

This ‘quick tip’ is probably only applicable to about 1% of our readers right now, but if you’re like me then hopefully this will strike you as such amazing information that you’ll store it away somewhere and think about it when you have a child who is about 13 years-old:

Anyone who has ‘earned income’ in a calendar year is eligible to contribute to a Roth-IRA and this includes children (I’ve heard of this as young as 13 years-old).  As many of you know, compound interest is one of the most powerful concepts on earth, and nowhere is it more vivid than in this chart:

AgeInvested9% Return8% Return
135,500315,797204,776
145,500289,722189,607
155,500265,800175,562
165,500243,853162,558
175,500223,719150,517
185,500205,246139,367
195,500188,299129,044
205,500172,752119,485
215,500158,488110,634
225,500145,402102,439
Total:55,0002,209,0781,483,989

As you can see, if a person contributes the current maximum of $5,500 each year from the time they turn 13 to the time they turn 21, at a 9% annual growth rate, it will be over $2.2 million at age 60 when they are eligible to withdraw it from your Roth-IRA (59.5 is the earliest standard withdrawal age).

Additional Benefits: Fees and Taxes

(Incidentally, this chart should show you just how important it is to keep your expenses down when investing!  The 1% difference each year compounds to over a $700,000 difference when age 60 rolls around.  Many people don’t think twice about paying “financial advisers” 1% or 1.5% of their assets each year, since it sounds like a small number, but this shows just how important it is.  Invest in low cost mutual funds and ETFs and you’ll beat those advisers 99 times out of 100)

Unlike a 401k or a traditional IRA, the Roth-IRA withdrawals are completely tax free, so 100% of it is theirs to keep!

Think about that for a second:  if you put $5,500 in annually from age 13 through when you graduated college, you would never have to save another dollar for retirement as it would already be done!

Most kids don’t have an extra $5,500 lying around each year, and even if they did, I’m not sure a Roth-IRA would be their money destination of choice.  That said, parents, grandparents, relatives, etc. are able to contribute for them, as long as the contribution is below the amount of earned income the child had that calendar year (including babysitting, lawn mowing, etc., which is reported on their tax return).

So if you want to ensure your kids (and in turn your grandkids) will be rich one day, a Roth-IRA at a very young age can be an amazing way to go about it!

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Comments

  1. Mr. 1500 says

    August 6, 2013 at 11:12 am

    Neat! We have two daughters, so learning how to best help them is very important to us. I have a question about this that I think you could probably help out with:

    “Anyone who has ‘earned income’ in a calendar year is eligible to contribute to a Roth-IRA and this includes children (I’ve heard of this as young as 13 years-old).”

    What is the definition of earned income? For example, can I pay my child to rake leaves? I don’t want to do anything questionable, but perhaps there is a way to employ my children before they can get real jobs.

    As a side not, since you and both have kids, I’d really like to see (future post?) how you’re raising them to be good, financially responsible people instead of crazy-ass consumers. Sometimes, I feel like I’m in a constant battle against society!
    Mr. 1500 recently posted…Performance Update 7 of 50: Oh my, July!My Profile

    Reply
    • Brad says

      August 11, 2013 at 8:47 pm

      Mr. 1500,

      Thanks for stopping by — I absolutely love your site and think it’s one of the top personal finance websites around!

      I researched the earned income question as it relates to Roth-IRAs for children and there’s still some uncertainty. I plan to call the IRS this week to discuss and I’ll report back with my findings.

      I called Fidelity to discuss and disappointingly they do not open accounts for anyone under the age of 18. So a minor could not open a Roth-IRA at Fidelity. Their rep understood what I was getting at and tried to discuss the earned income question, but couldn’t give me the certainty I needed.

      Here’s a link from the IRS that defines earned income: http://www.irs.gov/Individuals/What-is-Earned-Income%3F

      I read through the Publication 590 on IRAs and it mostly discusses W-2 earnings and such: http://www.irs.gov/pub/irs-pdf/p590.pdf

      Here’s a link that has some analysis on Roth IRAs for Minors: http://fairmark.com/rothira/minors.htm

      You brought up a great idea for a new post regarding how to raise the girls to be financially responsible and not typical consumers. Laura and I think about this constantly, and though we don’t know for certain what we did right, it certainly seems that our 5-year old is not a typical consumer. She literally never asks for anything other than a 50 cent box of markers so she can do her artwork. She never asks for anything for her birthday or the holidays, as it just isn’t on her mind to ‘want’ anything.

      I think it’s largely because we don’t make a big deal out of wanting anything as a family or as individuals. We never talk about ‘oh, what are we going to get for our birthdays’ or talk about the next gadget or gaming system or whatever else other people waste their money on.

      We just spend as much quality time together as we can. We talk to our kids, we challenge them to learn new things, and we mostly play outside together. They’ve never used a video game system, we never bought a DVD player for the car (even though it would have make our lives easier), etc.

      Reply
  2. Caryl Anne says

    June 11, 2014 at 9:55 am

    Excellent post! There is a lot of great information within this article I’m sure anyone could use or follow. Thanks for sharing!

    Reply
    • Brad says

      June 16, 2014 at 4:35 pm

      I’m glad you enjoyed it! This is something I plan to do when my kids are slightly older…

      Reply

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