Roth IRA for Kids

A Roth IRA for Kids (also known as a 'Custodial Roth IRA') is a special type of retirement savings account designed for minors. It's one of the most powerful tools you can give a child to build wealth over their lifetime. Just like a standard Roth IRA for adults, contributions are made with money that has already been taxed (post-tax dollars). The real magic happens inside the account: the investments grow completely tax-free, and when the child eventually retires decades later, all withdrawals are also 100% tax-free. The account is “custodial,” meaning an adult (usually a parent or guardian) opens and manages the account on behalf of the child until they reach the legal age of majority in their state (typically 18 or 21). At that point, the child gains full control. The one crucial rule is that the child must have legitimate earned income to be eligible to contribute. This account isn't just about saving; it's a masterclass in long-term investing, teaching the incredible power of compound interest from the earliest possible age.

Think of a Roth IRA for Kids as a time machine for wealth. By starting in their youth, a child gains the most valuable asset in investing: an incredibly long time horizon.

Albert Einstein reportedly called compound interest the “eighth wonder of the world.” This account is the perfect laboratory to see it in action. A small contribution of $1,000 made for a 15-year-old could grow to over $100,000 by age 65, assuming an average annual return of 8%, without ever adding another penny. The growth isn't just on the initial money but on the accumulated earnings, creating a snowball effect that turns small sums into a substantial nest egg over 50+ years.

The tax treatment is what makes the Roth structure so brilliant for a young person.

• Contributions: Made with post-tax money. For a kid with a small summer job, their income tax bracket is likely zero or very low, so there's little to no tax “sting” upfront.
• Growth: All investment growth—from stocks, Exchange-Traded Funds (ETFs), or mutual funds—is completely tax-free. Forever.
• Withdrawals: After age 59 ½, every dollar withdrawn is tax-free. This is a monumental advantage compared to tax-deferred accounts like a traditional 401(k), where retirees pay income tax on withdrawals.

While the concept is powerful, there are a few key rules set by the Internal Revenue Service (IRS) that you must follow.

This is the most important requirement. A child can only contribute to a Roth IRA if they have legitimate earned income from a job. Gifts or allowance do not count.

• What counts as earned income?
  • A formal job with a W-2 form (e.g., working at the local ice cream shop).
  • Self-employment or “gig” work (e.g., babysitting, mowing lawns, dog walking, tutoring, monetizing a YouTube channel).
• Pro Tip: Keep meticulous records! If the child is self-employed, create invoices or a simple spreadsheet logging the date, the service provided, the customer, and the amount paid. This creates a clear paper trail in case the IRS ever asks.

The amount a child can contribute each year is limited. It's the lesser of these two amounts:

1. Their total earned income for the year.
2. The maximum annual IRA contribution limit for that year (for 2024, this is $7,000).

Example: If your 16-year-old daughter earns $2,500 from a summer lifeguarding job, she can contribute up to $2,500 to her Roth IRA for that year. If she earned $8,000, her contribution would be capped at the $7,000 annual limit. A parent or grandparent can make the contribution on the child's behalf, as long as the amount doesn't exceed the child's earned income.

Since minors cannot legally open their own investment accounts, the Roth IRA is set up as a custodial account.

• The adult custodian is responsible for opening the account, choosing the investments, and managing any trades.
• The account is legally the child's property (registered under their name and Social Security number).
• When the child reaches the age of majority, control of the account is transferred to them.

For a value investing enthusiast, the Custodial Roth IRA is more than a financial product; it's a teaching tool. It's the ultimate vehicle for instilling the core principles of long-term, patient investing.

• Focus on Time, Not Timing: With a 50+ year horizon, the temptation to engage in short-term speculation disappears. You can teach your child to ignore market noise and focus on the fundamental value of the businesses they are buying.
• Buy Great Companies: Use the account to teach your child how to identify wonderful businesses with durable competitive advantages—companies they understand and can hold for decades.
• Power of Reinvestment: Show them how dividends from their investments can be reinvested to buy more shares, turbocharging the compounding process. This is the bedrock of building generational wealth.

Opening a Roth IRA for your child isn't just giving them a financial head start. It's an opportunity to teach them the discipline, patience, and long-term perspective that define a successful investor.