Can You Open A Roth IRA For Your Child?

January 10, 2018

The short answer is, yes, as long as your child has earned income, you can open a Roth IRA in their name and contribute up to the lower of either their total earned income or the annual limit ($5,500 for 2018). But there are some watch-outs to be aware of first.

Defining earned income

The key here is that the money you’re depositing into the Roth IRA is earned. That includes doing things like mowing the lawn, baby-sitting, cleaning the house (thinking back to when my parents paid me $12 to clean the whole house each week — holy inflation!), etc., you just have to be sure to document it. A part-time job where your kid receives a W-2 is a no-brainer — that’s 100% earned income.

What’s not earned income

Investment earnings, which are actually taxed differently, as well as gifts and allowance do not qualify as earned income and therefore cannot be counted toward the amount your child can contribute to a Roth IRA. In other words, you can’t just put $5,500 in a Roth IRA in your kid’s name, then say that they earned it by “being a good kid.” That’s a gift.

However, if they actually earned $5,500, even if they spent it on things like clothes and video games, you can still put that amount in their Roth IRA — the IRS only cares that the amount was actually earned by the account owner. Think of it like a match: you go get a job and learn some responsibility, and I’ll match those earnings in your Roth. A win-win!

Documenting earned income

If you’re using money your child earned doing tasks around the house rather than for a formal employer, one way to document it is to keep detailed records. You’ll want to document:

  • How much was earned
  • What was done to earn it
  • When it was earned

So for example, you could have a log that simply says: “1/1/2018, Baby-sitting for the neighbors on New Year’s Eve, $100.” You could file a tax return to really formalize the documentation, but it’s not required.

However, once your dependent child’s earned income exceeds the annual limit ($6,350 for 2017), they are required to file their own federal income tax return, regardless of the source of the income. There are reasons to file if their income was less, particularly if federal income taxes were withheld, so that they can have that money refunded. I always get a kick out of seeing my Social Security statement, which lists my first working year’s earnings as $136 from my first couple months working at McDonald’s!

Setting your child up for future financial independence

The bottom line is, one way to help your kid establish good savings habits from an early age is to open that Roth IRA as soon as he/she can legitimately earn money — in some families, that could be as early as 3 years old. You’ll have to open a custodial account until your kid is over age 18 (or 21, depending on your state), but most of the large investment companies allow these types of accounts. Keep in mind that because this is technically a retirement account, these savings wouldn’t even count again you when it comes to filing for college financial aid.

What better way to get your kids off on the right financial foot?

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