Family Money
by Janis Brett Elspas, Editor
Mommy Blog Expert
MBE partnered with Responsival for this post
Saving for Your Child's Future
With savings interest rates so low right now, it's the ideal time to think about other ways to get each of your kids started with building a nest egg that continues to grow throughout childhood and into their 20-something years and beyond. While far less common, a solid option to consider is a Custodial Roth IRA which parents and legal guardians can set up for children. Not only does this present the opportunity to teach kids about money management early it also helps them build long-term wealth at a higher rate, giving kids a headstart on financial independence.
Custodial Roth IRA for Kids Basics
You may be wondering what on earth is a Custodial Roth IRA? And why you should you even care about setting up one for your son or daughter? So, let's get right into it.
In the simplest terms the Custodial Roth IRA is a retirement account for kids. It's managed by you and you can be set up an account for any age child. When the minor reaches the legal age of adulthood (typically 18 or 21 years old) the funds in the account are transfered into their name. This type of child's account is just like a standard Roth IRA for grownups -- after‑tax dollars earned from work by the contributor go in and qualified withdrawals later are tax‑free.
You can contribute the amount your child earns each year, whether from teenager earned income like babysitting, mowing lawns, modeling, or any W‑2 part-time or summer job. Parents, Grandparents and others may also contribute their own earned income until the child's account reaches a maximum of $7,000 of deposits per year as of 2025. The main difference from a Roth IRA is that mom, dad, or a legal guardian has to be the one to open and oversee the custodial account since minors can’t legally sign on their own.
Why Consider Custodial Roth IRAs for Kids
Compound Interest is "Magic"
Starting young, small contributions from kids part-time jobs can indeed grow huge over time. While not really magical, here's an example. With a $7,000 initial balance the first year, a Custodial Roth IRA (currently the average return rate is 6 percent) can potentially compound -- because both the principal and accumulated interest earn interest -- to almost $140,000 in 50 years.
You can get a more personalized estimate of earnings based on what you think your account contributions might be with this free compound interest calculator.
Contribution Accessibility
You can withdraw the money you put into a Custodial Roth IRA at any time without taxes or penalties. This is a really useful strategy when your teen needs funds for a big expense such as college, a car, or perhaps even a backpack trip to Europe. Later an adult child may tap into their account for bigger expenses for things like buying a starter home. Remember, however, that like regular Roth IRAs, the withdrawal of any tax free earnings are subject to the Roth rules of a 5-year holding period, wait until age 59.5 or meeting qualifying exceptions.
Kids Usually Are In the Lowest Tax Bracket
Since the average child doesn't earn a salary or have a full-time, year-round job, they generally pay little or no income tax for the jobs they earn money for. In this position, the after-tax structure of a Custodial Roth IRA is advantageous for them. Not only are they paying less tax now while they are under age, they're getting access to tax-free withdrawal decades later when they're likely to be earning a lot more money because they're in a higher income bracket.
Smart Saving for the Future is Educational
Once a child has grasped simple math concepts in school, it's a good time to introduce them to their Custodial Roth IRA.
Get creative with age-appropriate ways to teach and show them how interest works and how their money can increase. For example, for a 5 or 6 year-old you can use coins and show them how money can increase if they're saving it in this type of Roth IRA for kids.
Over time, with your encouragement, tween and teens can work on more complex mathmatical challenges under your guidance working together with you to manage their investment, teaching them responsibility, budgeting and the benefits of saving early. It's a finance lesson they won't forget and will serve them for a lifetime.
Conclusion
In short, Custodial Roth IRAs are under-utilized in the US as only a low percent of kids currently have one. Yet, this is a powerful tool worth knowing about. It's an investment that combines a smart tax strategy, flexibility, education and money responsibility, with compounding earnings over time.
Sure, your child is young, but starting their financial journey early and watching it grow together is one of the best gifts you can give them!
