Setting up a Roth IRA for your child can be a smart financial move with long-term benefits. It can also help them get started saving for retirement or other life events early. For 2024, the maximum contribution is $7,000 for those under age 50. 

Time is a powerful ally when it comes to investing. Even modest contributions made now could snowball into a substantial nest egg by the time they reach retirement age. 

Benefits

One of the most significant perks of a Roth IRA is tax-free growth. Unlike traditional IRAs or 401(k)s, where you contribute pre-tax dollars but pay taxes upon withdrawal, Roth IRAs allow your investments to grow tax-free. This means your child won’t owe taxes on any earnings, dividends, or capital gains generated within the account. Over time, this tax-free growth can significantly enhance the account’s overall value.

Roth IRAs also offer more flexibility than other retirement accounts. Contributions (but not earnings) can be withdrawn penalty-free at any time and for any reason. This flexibility can come in handy if your child needs access to funds for education, buying a home, or unforeseen expenses. 

While Roth IRAs are primarily retirement accounts, they can also serve as a source of funds for educational expenses. Withdrawals of earnings are typically tax-free if used for qualified educational expenses, providing another avenue to help your child pursue their academic goals. However, if your main goal is saving for retirement, a 529 plan is likely a better option.

If your child doesn’t need the funds in their Roth IRA during their lifetime, they can pass it on to their heirs. Inherited Roth IRAs offer tax-free growth for beneficiaries, providing a valuable legacy for future generations. This potential for intergenerational wealth transfer adds another layer of long-term financial planning benefits.

Limitations  

A Roth IRA requires that the account holder have earned income to contribute to the account. This means the child must have income from a job or self-employment to qualify. For younger children, earned income may come from jobs such as babysitting, lawn mowing, or working part-time at a local business. As they get older, they may take on more substantial employment, such as internships or summer jobs, increasing their contribution.

At some point, your child may be unable to make Roth contributions. Contributions can be limited as they enter the workforce and participate in a retirement plan. For 2024, the contribution starts phasing out at $146,000 of income, and no contribution is allowed at $161,000. 

If you like the idea of setting up a Roth, don’t wait until tax time. Go ahead and set up the account now rather than scrambling at the last minute. You have until April 15, 2025, to make a 2024 Roth contribution.