What Is A Custodial Roth IRA? - NerdWallet (2024)

FAQs

What does custodial Roth IRA mean? ›

What is a Custodial IRA? A Custodial IRA is an account that a custodian (typically a parent) holds for a minor with earned income. Once the Custodial IRA is open, all assets are managed by the custodian until the child reaches age 18 (or 25 in some states).

A Custodial Roth IRA presents a unique opportunity to foster early financial growth and education for minors. However, it's crucial to weigh these advantages against potential drawbacks, including loss of control, contribution limits, financial aid implications, and tax penalties.

Also, it is possible to fund a child's Roth IRA for the prior tax year until April 15^th of the current year. EXAMPLE: Jill, 16, earned $3,000 as a lifeguard. Jill's parents or another family member can set up and contribute to a Roth IRA (up to a maximum of $3,000, the amount Jill earned) on her behalf.

Roth IRA vs.

Unlike Roth IRAs or 529 plans, UTMAs and UGMAs don't have income tax benefits, but they're more flexible: The custodian can withdraw the money for any purpose that benefits the child. These accounts also don't have an earned income requirement, nor do they have contribution limits.

Cons: Any contributions you make to a custodial Roth IRA become the child's money - you can't take it back if they act irresponsibly once they control the account. The child won't have access to profits without penalties (with some exceptions) until they reach 59 ½ under current rules.

The parent or guardian opens and controls the account while the child is a minor. Once the child turns 18 or 25 (depending on the state), parents give up control of the account, which then becomes a regular non-custodial Roth IRA.

Pros of a Custodial IRA

Custodial Roth IRAs usually earn more than a traditional child's savings account. The Roth IRA is a good choice for someone in a lower tax bracket, which usually applies to a child. A child's earnings may be so low that they are not taxable.

Both Roth IRAs and custodial Roth IRAs are funded with post-tax money. This setup means that your contributions can always be withdrawn at any time, tax-free and penalty-free. Earnings on the account, however, will be subject to penalty and taxes, if taken out before age 59 1/2.

Opening a custodial account for the child in your life can be an excellent way to set them up for future financial success. But, as with anything related to money, you must consider the tax consequences. You may owe taxes at both your rate and the child's, and they might even have to file a tax return.

Since there's no age restriction on Roth IRA accounts, families can use them to help kids get a head start on both retirement savings and wealth-building goals. Not only is it an opportunity for parents and children to talk about saving and investing, but the money potentially benefits from decades of tax-free growth.

How do I prove my child's income for a Roth IRA? ›

Ideally your child should have a W2 or a Form 1099 to show evidence of the earned income. However, there are some instances where this may not be possible so it's important to keep records of the type of work, when the work was done, who the work was done for and how much your child was paid.

In general, the Roth IRA is the IRA of choice for minors who have limited income now. By the same logic, it's often recommended for adults who expect to be in a higher tax bracket in the future. "If a child keeps [a Roth] until age 59½ (under today's rules), any withdrawal will be tax-free.

A custodial Roth IRA is unique in that the person who will benefit from the account isn't the person who owns it. Because you must be at least 18 years old to open an investment account, a child requires an adult to open one on their behalf. In this case, that adult is known as the custodian.

The Roth IRA contribution limit is $7,000 in 2024 ($8,000 if age 50 or older) or the total of earned income for the year, whichever is less. If a child earns $2,000 babysitting, they can contribute up to $2,000 to a Roth IRA.

Custodial accounts may not offer the tax benefits of 529 plans, but they can be used to fund expenses that 529 plans don't cover. If you want to set aside money for college expenses that aren't covered by an Education Savings Account (ESA) or 529 plan, a custodial account might help.

Unlike many tax-advantaged retirement accounts, you can access the money in a Roth IRA early. Though your child's investment earnings will still be subject to withdrawal restrictions, the original contributions can be withdrawn at any time tax-free and penalty-free.

After the Roth IRA has been funded for five years, your child can take out up to $10,000 in earnings to buy a first home, tax- and penalty-free. Roth IRA earnings can be used for qualified education expenses, such as college tuition. Earnings distributed will be taxed as income, but there will be no penalty.

Upon the beneficiary's reaching the age of majority, the custodian has a duty to turn the account over to the beneficiary, at which time the beneficiary will become the account owner with complete authority over the account.