Roth Contributions for Kids

If the teen or young adult in your life hasn’t brought it up already (and they may have! - they definitely have a higher rate of financial literacy than any of us had at that same age), be aware that their peer group may be talking about Roth IRAs and how best to use them.

So, what makes a Roth so great?

Because Roth IRAs have long-term tax benefits (potential tax-free withdrawals) but no present-day deduction for contributions, they are particularly good savings vehicles for people who are young, single, and early in their careers – all of which point to being in a low tax bracket (possibly even paying nothing in taxes). That is, contributions are made with after-tax funds, but if those funds are only taxed at 0% or 10%, that’s a pretty tiny disadvantage, compared to that same person making contributions say, 10 or 20 years from now, when he or she is likely to have higher income, or potentially be married with two incomes in the household.

Making contributions – things to consider

Account owners under age 50 can contribute up to whatever they earned during the year, or up to $7,000 (the 2024 limit), whichever is less. This often means that young Roth IRA owners with unpredictable income sometimes do well to wait until a draft of their tax return is completed the following spring, in order to see how much they earned over the prior year. (The deadline for Roth IRA contributions is April 15th of the following year.) This technique avoids someone contributing, say, $2,000 during 2024, only to realize once the return is drafted that they only earned $1,800 for the year (thus having to remove both the excess contribution as well as its growth – an administrative hassle).

One common concern is the source of the contribution funds. Good news here: there are not any rules about who can provide the funds for the account owner to use to make the contribution, so there’s lot of flexibility. That is, (often impoverished) teens and young adults frequently don’t have funds for their contribution readily available every April. In this case, parents or grandparents can certainly step in to provide funding. The federal government doesn’t care who provides the funds.

A great parenting teaching moment that can stem from this is that parents can teach kids to think ahead about saving up for their annual Roth contribution. Further, clever parents can help kids have some skin in the game – that is, offering kids some type of matching program (“for every dollar you contribute, we’ll match it,” or “if you contribute $500, your father and I will add an additional $250,” or whatever works for your budget).

A few other details

A child of any age can fund a Roth IRA, though kids under 18 generally have to have a “custodial” Roth account with a parent as the owner, until the child becomes of age. (The particular age can vary by state, though it’s 18 in most of them.)

To be eligible to make contributions, the teen has to have income from a job (vs. from income in a savings account). But, the job doesn’t have to be a formal one that will issue a 1099 at the end of the year – informal jobs are enough to qualify (mowing lawns, babysitting, etc. all count). Whether or not this income triggers a tax return needing to be filed is another matter (check with your tax professional) – but if not, be sure to keep a log of the child’s income in case they are ever questioned about their eligibility to have made Roth contributions.

Roth IRAs can be power long-term savings tools – parents with working teens or young adults should be sure to not miss this savings, investing, and learning opportunity that is a great companion to a summer job.