Retirement isn’t top of mind for most teens, but it should be. A relatively small investment made today can turn into a much larger sum tomorrow, after a few decades of compounding. A good way to start is with a Roth IRA. But Can teens open Roth IRAs? This is precisely the topic we will address today.
Can teens open Roth IRAs?
- A Roth IRA can set teens up for a comfortable financial future.
- Anyone with income can contribute to a Roth IRA.
- Children under the age of 18 need a custodial Roth IRA.
Tax-Free Growth and Retirement Income
One of the biggest advantages of the Roth IRA is the tax exemption it offers. And while with the Roth IRA, you don’t get an upfront tax reduction like you do with a traditional IRA, your contributions and earnings grow tax-free forever.
This generally works well for teenagers. Since most of them pay little or no income tax. If a teen has a summer job, or works during the school year, their pay makes them eligible for a Roth. Is that how it works:
- Any Roth IRA contribution made now isn’t deductible, but the deduction wouldn’t be as valuable anyway. Later, a teenager falls into a higher tax bracket, they will not have to pay any taxes on that money.
- Contributions can be withdrawn at any time, for any reason, without paying taxes or penalties. The above as long as the account holder is at least 59 1⁄2 years old. Otherwise, to withdraw the money from the contributions, you will have a 10% penalty for early withdrawal.
Yes, teens can open Roth IRAs.
Anyone can contribute to a Roth IRA, regardless of age. That includes babies, teens, and great-grandparents. Contributors only need to have income during the year in which they make the contribution.
People earn income when they work for someone who pays them, or when they own a business or farm. Although babies are unlikely to have income from work, unless they’re child models or actors, the type of work teens typically do — babysitting, lifeguarding, making burgers, and so on — qualifies. Investment income does not qualify.
Individual account contribution limits change periodically based on inflation. For 2019 and 2020, workers can contribute up to $6,000 a year to a Roth IRA ($7,000 for those 50 and older). But the contribution can only be as large as the individual’s earned income. If a teen earned $4,000 for the year, that’s the most she can bring.
The payment received must be legitimate and at the market exchange rate. Parents, for example, can’t pay their kids $1,000 an hour to mow lawns and call it work income. Ideally, the taxpayer would receive a W-2 form to substantiate her income. Otherwise, it’s a good idea to keep excellent records for odd jobs that don’t provide a W-2.
Teens can open Roth IRAs and receive adult contributions
Parents and other adults can “match” a teen’s earnings and make a contribution themselves. For example, if a teenager earns $3,000 from a summer job, their parents can put up the $3,000 and let their son or daughter spend (or save) their money. Or they can help by contributing a percentage of the teen’s earnings, say 50%.
Parents can contribute money to a teen’s Roth IRA as long as the teen earns at least that amount.
The Internal Revenue Service (IRS) doesn’t care who makes the contribution. The teen just needs enough income to equal (or exceed) the contribution.
How to open a Roth IRA for a teenager
An adult must open the custodial Roth IRA for a minor. In most states, that’s 18, but in others it’s 19 or 21.
Custodial Roth IRAs are basically the same as standard Roth IRAs, but the minimum investment amount may be less. Many, but not all, brokers offer custodial Roth IRAs.
Companies currently offering accounts for minors include Charles Schwab, E*Trade, Fidelity, Merrill Edge, TD Ameritrade and Vanguard.
As custodian, the adult controls the Roth IRA assets until the minor reaches the age of majority. From then on, the account belongs to the minor, and the minor can continue to invest in their Roth IRA so that their financial future is strong.