Supercharge Gifts To Kids With Roth IRAs
- Tax Smart Charitable Gifting - September 13, 2019
- How To Use 529 Plans To Leverage A Wealth Transfer - April 24, 2018
- Investing Under The New Tax Law: These Haven’t Changed, but Don’t Forget Them! - April 17, 2018
As the summer winds down, kids are returning to school, pockets overflowing with cash earned from summer jobs/internships. Is there an opportunity for these summer jobs to begin securing your child’s or grandchildren financial future? You bet there is, and it has arrived gift wrapped within the tax code in the form of a Roth IRA. (Not too sure about the difference between Roth and Traditional IRAs? Read more here!)
Many of us are familiar with Roth IRAs for use in our retirement savings, however many don’t know that this vehicle can also be used to jump start a child’s long-term savings program. It works in the same fashion that most of us use to save for our long-term financial independence; funding the account with your savings dollars and then allowing the investments to compound tax-free for the life of the account owner.
Let’s quickly review the basics of the Roth IRAs.
- You must have earned income to be eligible to make a contribution.
- The account contribution is not tax deductible.
- The earnings on the account compound tax-deferred each year.
- Distributions will be tax-free if properly qualified.
In today’s world of investing and savings, it’s hard to find a more attractive long-term investment vehicle. To top it all off, the account can be funded with a gift from parents, grandparents or anyone else willing to fund the account. Of course, if the funds do not come from the child’s assets, the funding will be counted as a gift, subject to the possible gift tax implications. Remember though, in 2017, gifts of up to $14,000 per year fall under the annual exclusion exemption and are not subject to any tax reporting requirement.
The Roth IRA account can also be a great opportunity to introduce the child to the world of investing. Once the account is setup and funded, the investments can be selected and followed with the child. This can help introduce children or young adults to saving and investing early in their lives, laying the foundation for a better understanding of finances over their lifetime. (Want to know more about teaching your children about finances? Click here to read another article by Lindsay Garland, CIMA®, CES™)
The power of compounding investment returns will also get a huge head start by starting a child with retirement accounts in their teen years. As an example, a one-time $5,500 contribution into a child’s Roth IRA at age 15, will result in an account worth over $160,000 by age 65 (assuming a 7% annual return). The growth of Roth IRA funds over the child’s lifetime will result in a number of potential uses for the money.
While the final use of the funds determines the income tax treatment, typical Roth IRA distributions are completely free of any taxes or penalties after a five-year holding period. Here are the payout options:
- For retirement, after the age of 59-1/2, there are no income taxes or penalties.
- Applying funds towards the purchase of a home; up to $10,000 for down payment or closing costs, without any income taxes or penalties.
- Due to death or disability, no income taxes or penalties.
- For educational expenses; funds withdrawn for qualified education expenses are subject to income taxes on the earnings, but no penalties.
- Other uses of funds from the Roth IRA, will be subject to income taxes on the earnings plus a 10% penalty, but can still function well as an emergency resource.
The Roth IRA for kids is quickly becoming more widely available through discount brokerages such as Schwab, Fidelity and others. You can fund these accounts with small amounts of $500 or $1,000, and up to the annual maximum of $5,500 (2017 limit). The account would initially be setup as a custodial Roth IRA, if the child is under the age of 18 (21 in some states) but would be fully titled to the child upon the reaching the age of majority.
Please contact us if you have questions on using Roth IRAs to jumpstart your children’s or grandchildren’s financial futures. To learn more about why we find it so important to work with the entire family, click here to read another article by Barry Glassman, CFP®, Founder and President of Glassman Wealth.