Custodial Roth IRA: How Does It Benefit Your Child?

By Hetal Bansal

Tax-free withdrawals in retirement

A custodial Roth IRA is a retirement savings account that allows parents or guardians to save for their child's future. The account is held in the child's name, but the parent or guardian manages the account until the child reaches the age of majority. One of the significant advantages of a custodial Roth IRA is that it offers tax-free growth and tax-free withdrawals in retirement. The contributions made to the account are made with after-tax dollars, meaning the money grows tax-free and can be withdrawn tax-free in retirement.

Another benefit of a custodial Roth IRA is that it provides a great opportunity for parents to teach their children about the importance of saving and investing for the future. By starting to save at a young age, children can benefit from decades of compound interest and potentially build a significant nest egg for their individual retirement.

Custodial Roth IRAs offer tax-free growth

Custodial Roth Ira Rules

Custodial Roth IRAs offer several advantages, including tax-free growth, no required minimum distributions (RMDs), and the ability to withdraw contributions penalty-free at any time. However, some important rules must be followed to maximize the benefits of these accounts.

The first rule to keep in mind is that only earned income can be contributed to a custodial Roth IRA. This means that the child must have income from a job or self-employment to make contributions to the account. The maximum contribution limit for 2023 is $6,000, or the child's total earned income for the year, whichever is less.

Another important rule is that contributions to a custodial Roth IRA must be made in cash. This means that stocks, bonds, or other assets cannot be directly transferred into the account. However, the child can use their contributions to purchase investments within the account, such as mutual funds or ETFs.

One of the key benefits of a custodial Roth IRA is tax-free growth. This means that any earnings within the account, such as interest, dividends, or capital gains, are not subject to income tax. However, to take advantage of this benefit, the account must be held for at least five years, and the child must be at least 59 years old before any withdrawals can be made.

In addition to tax-free growth, custodial Roth IRAs also offer the flexibility to withdraw contributions penalty-free at any time. This means that if the child needs to access the money for an emergency or other expenses, they can do so without incurring a tax or penalty. However, it's important to remember that any earnings withdrawn before age 59 will be subject to income tax and a 10% early withdrawal penalty.

Another advantage of custodial Roth IRAs is that there are no required minimum distributions (RMDs). This means that the child can leave the money in the account to continue growing tax-free for as long as they want. However, once the account is transferred to the child at age 18, they will need to start taking RMDs if they are still working and earning income.

Finally, it's important to note that custodial Roth IRAs are subject to the same contribution and income limits as traditional Roth IRAs. This means that if the child's income exceeds certain thresholds, they may not be eligible to contribute to the account.

 

Limits to Custodial Roth Ira

There are limits to the contributions that can be made to a custodial Roth IRA. The contribution limit for a custodial Roth IRA is the same as for a traditional Roth IRA. In 2023, the maximum contribution limit is $6,000, or the child's total earned income for the year, whichever is less. For example, if a child earns $3,000 from a part-time job in 2023, the maximum contribution that can be made to their custodial Roth IRA for that year is $3,000.

It's important to note that the contribution limit applies to all IRA accounts held by the child. For example, if the child has a part-time job and also earns income from a summer internship, the total amount of contributions that can be made to their IRA accounts cannot exceed $6,000 in 2023.

There are also income limits to consider when contributing to a custodial Roth IRA. If the child's income exceeds certain thresholds, they may not be eligible to contribute to a Roth IRA. In 2023, the income limit for a single filer is $145,000, and for married filers, it is $208,000. If the child's income exceeds these limits, they may be able to contribute to a traditional IRA instead, which has different tax advantages.

It's also important to remember that contributions to a custodial Roth IRA must be made in cash. This means that stocks, bonds, or other assets cannot be directly transferred into the account. However, the child can use their contributions to purchase investments within the account, such as mutual funds or ETFs.

 

Custodial Roth IRA Procedure

Opening a custodial Roth IRA for a minor is a straightforward process that can be done online or in person with a financial institution that offers IRA accounts. Here's a step-by-step guide to the procedure:

 

Choose a custodian

The first step is to choose a financial institution that offers custodial Roth IRAs. This could be a bank, credit union, brokerage firm, or online investment platform.

 

Gather required information

You'll need to provide some personal information for the child, such as their name, date of birth, and Social Security number. You'll also need to provide information about yourself as the custodian.

 

Fund the account

You can fund the account with cash or a check. The maximum contribution limit for 2023 is $6,000, or the child's total earned income for the year, whichever is less.

 

Choose investments

Once the account is funded, you can choose how to invest the money. Many custodial Roth IRAs offer a variety of investment options, such as mutual funds, ETFs, and individual stocks.

 

Manage the account

As the custodian, you'll be responsible for managing the account until the child reaches the age of majority. This includes making investment decisions, monitoring the account's performance, and keeping track of contributions and withdrawals.

 

Transfer the account

When the child reaches the age of majority, the account will be transferred to their name. At that point, they will be responsible for managing the account and making investment decisions.

 

Conclusion

In conclusion, a custodial Roth IRA is an excellent way for parents and guardians to help their children save for retirement and set them on the path to financial security. By opening a custodial Roth IRA, parents can take advantage of tax-free growth, flexibility in terms of withdrawals, and a range of investment options. However, it's important to keep in mind the contribution and income limits, as well as the procedures for opening and managing the account. By following these rules and procedures, parents and guardians can help their children take advantage of the benefits of a custodial Roth IRA and prepare for a financially secure future.