A Retirement Account for Kids: Roth IRAs Are The Way

Why would you want to do this? Well, it all has to do with three very important components of Roth IRAs:

• First, given that the child is very likely to either owe no income tax at all, or will be in the lowest of low tax brackets, this is essentially free money that will grow tax free for your child’s entire life. As we’ve covered before, a Roth IRA, if left alone until at least age 59 1/2, will never be taxed. Plus, the Roth IRA doesn’t have a Required Distribution (as the traditional IRA does).
• Second, the contributions to the Roth IRA can be withdrawn at any time for any reason, without tax or penalty. This means that, although the earnings in the account would need to be left alone (or you’d have to pay tax on the earnings, plus a penalty), you could use the money set aside in this account to help pay for college, make a down payment on a car, or whatever makes sense. Obviously, you’d want to consider raiding this account as your last resort, due to the preferential tax treatment (see first bullet above), but it does give you much more flexibility than most retirement accounts.
• Third, since the Roth IRA is a retirement account, funds in a Roth IRA are not counted as available assets in the Federal formula for college financial aid. Because of this provision, if you are planning to use Roth funds to help pay for college (see second bullet above) you may want to be very careful about your timing. Once you use the Roth IRA funds, the following year when you re-file the FAFSA form, you’d have to include the amount that you withdrew as income to the student (for the previous year).

As you can see – for savings that we want to “lock up” from the child, but still have access to in the worst possible case, a Roth IRA makes sense for lots of kids. If you’re unsure about how to set up a Roth IRA, your financial advisor should be able to help you out.

For additional information on Roth IRAs, go to financialducksinarow.com.