Setting up a Child IRA
It’s normal for parents to worry about their kids. Although young children’s retirement isn’t an immediate concern, smart parents can help their kids get a head start on saving for retirement by setting up a Child IRA. Here’s why it’s a good idea.
There’s no lower age limit when it comes to starting an IRA. A Child IRA is a custodial IRA that can be funded with pre- or post-tax money; it functions the same as a regular IRA except that there is a custodian overseeing the account.
A Child IRA can yield unbelievable results. If you contribute roughly $3 a day to a Child IRA from the moment a baby is born, that’s about $20 a week, $80 a month or $1,000 a year. If you do that every year until the child reaches the age of 19 and then stop contributing, assuming an 8% return per year, the child will have more than $2 million at the age of 70.
Is there a catch? Well, yes. While nothing prohibits a child from establishing a Child IRA, a child needs a paycheck to offset an IRA contribution. IRA rules say that to contribute to an Individual Retirement Account—at any age—you must have earned income, so you must have a job.
So, unless your kid is making diaper commercials, it’s more likely your children won’t make a whole lot of money until they’re teenagers. But that’s okay.
Teenagers are capable of working (and earning) more. With a summer job and part-time work during the school year, it’s not unreasonable to expect them to earn enough to contribute the maximum to their IRA ($6,000 beginning in the 2019 tax year).
Teenagers can create an IRA that will grow to nearly $2.5 million when they retire at age 70 (again, this assumes their investments grow at 8%). They simply need to begin saving the upper limit in their Child IRAs at age 13 and repeat this each year until they go to college at age 18.
One important note: Money can only be put into an IRA when someone earns income that is reported to the IRS; allowance money, gifts, or other savings your child has do not count as income and would not be eligible to go into an IRA. However, income earned from part-time or freelance work like babysitting or mowing lawns can count as long as you file the right income tax forms for your child. Self-employed parents can hire their children to do work for the business as long as that work is something the business legitimately needs to have done (i.e. someone else would have to do that work if the child didn’t). Please consult a tax professional before starting a Child IRA to make sure you follow IRS rules.
You should also be aware that a child’s income may affect any financial aid awarded based on the student’s need. On the other hand, such earnings are less likely to impact eligibility for true merit-based scholarships.
Establishing a Child IRA, even a small one, can excite your child by showing them the positive results of savings and investment growth. Consider starting one today.