Custodial Roth IRA: Should You Open One for Your Child?

Compound interest is a powerful financial tool. When you have a long time horizon to let money grow, even a modest amount of savings can turn into a substantial nest egg. Parents who know this concept often put it to work for their children by investing on their behalf when they are young. One option that can pay dividends many years into the future is opening a custodial Roth IRA on their behalf.

But these accounts aren’t just meant for high school seniors. If your child (or grandchild) is under the age of 18, they can also take advantage. Here’s more on what a custodial Roth IRA is, and why it can be a huge help later in life.

Custodial Roth IRA rules 

A custodial Roth IRA is a type of retirement account that a parent or guardian can open on behalf of someone age 18 or younger. The parent or guardian opens and controls the account while the child is a minor. Once the child becomes an adult, parents give up control of the account, which becomes a regular non-custodial Roth IRA. 

Parents or others cannot simply make contributions on their child’s behalf — only the child who is the account holder can do so. In order to contribute to a custodial Roth IRA, your child will need to earn some form of an income, such as from a part-time job. 

How much can your child contribute to a custodial IRA?

For 2022, your child’s contributions cannot exceed $6,000 (contribution limits can change annually). If your child earns less than $6,000 a year, they can only contribute as much as they earn.

Custodial Roth IRA vs. traditional IRA 

Just like with a Roth IRA, contributions to a custodial Roth IRA are made post-tax, meaning your child won’t have to pay taxes when he or she withdraws the money in retirement. With a traditional IRA, you make contributions with pre-tax income and then pay taxes when you withdraw the funds at whatever current tax bracket you’re in. Because your child is likely to be in a higher bracket at retirement age than in their teen years, a custodial Roth IRA typically makes more sense financially. 

How a custodial IRA can lay a financial foundation 

Even if they can’t afford to contribute much now, starting to save for retirement at a young age allows your child to take advantage of many decades’ worth of growth through the power of compound interest. 

Opening a custodial Roth IRA is also an opportunity to teach your child how to manage their money as well as the importance of saving for their future. Consider encouraging them to set up an automatic deposit from their paycheck to instill the habit of saving versus spending.

All investments carry some level of risk including the potential loss of all money invested.