Roth IRAs For Kids? Take A Closer Look

Most people don't confront the topic of IRAs until they are gainfully employed, but the conversation could be beneficial for minors. Traditional and Roth IRAs function differently, perhaps deadlocking the topic from family financial discussions. For one, both IRAs cannot be established until the potential account holder has taxable income.

On the other hand, Roth IRAs do not require a minimum taxable income amount. In other words, while a summer job at the local bookstore may not pay enough to require paying taxes, the income is still considered taxable, and therefore, the minor can contribute to a Roth IRA.

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What Makes A Roth IRA So Appealing For Minors?

Withdrawal Regulations

• No Requirement To Ever Withdraw: Unlike Traditional IRAs, Roth IRAs do not require withdrawals at any point in the account lifetime. Theoretically, contributions and earnings can remain untouched and willed to future generations.
• No Waiting To Withdraw: On the other end of the spectrum, Roth IRAs also allow the account holder to withdraw contribution amounts at any point, penalty-free. While Traditional IRAs require minimum withdrawals beginning at 70.5 years old and tax- penalty-free withdrawals can begin at 59.5 years old, Roth IRAs do not have these types of regulations.

Taxing Regulations

• Taxed On The Front: Contributions to Roth IRAs are not tax deductible. The amount contributed is factored in as part of the holder's total income – thus paying taxes on the amount that inevitably is put aside into the account. So, while the contribution cannot be deducted from the total income when filing taxes, taxes do not have to be paid (generally speaking) for the remainder of the account's lifespan.
• Tax-Free Growth: Because taxes are paid up front, Roth IRA holders avoid taxes on the backend. Therefore, the amount accrued in growth is tax-free; whatever the account earns throughout its lifespan is not taxed.

Related Link: When To Talk With Your Kids About Finances

Intermittent Contribution Regulations

• Stop And Go Contributing: Roth account holders can only contribute in years that taxable income was earned. So, if the minor worked one summer, then did not work the following year, he could not contribute in the year he did not work. The account would remain active and contributions could again be made once he began receiving taxable income once more.

Contribution Amount Limits

• Maximum Contributions Based On Age: Another issue of note, Roth IRAs have contribution limits. For example, the 2014 Roth IRA contribution maximum is $5,500 for those under 50 years old. Regardless of how much the account holder makes, no more than $5,500 can be contributed to the Roth IRA.
• Maximum Contributions Based On Income: One stipulation of particular importance for minors: if the total annual taxable income amounts to less than the contribution limit, the contribution limit decreases to match the income. So, if the account holder makes $5,499 in a year, he or she can only contribute up to $5,499 that year; if he or she only makes $2,000, she can only contribute $2,000.

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Time Is On Their Side

Keep in mind that if the account holder does not earn enough to have taxes due and contributes the maximum allowable, the contributions for that year are in essence tax-free, making Roth IRAs especially appealing for minors who are typically low-income earners. Even the most modest contributions, given 50 years' growth potential, can amount to some serious chunk change. The time value of money is unprecedented.