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Kids and Money: Early Retirement Savings with an IRA

We all want to teach our children [3] about good financial habits. Helping your child understand good financial practices, such as saving for the future, budgeting, and wise spending, can help your child start out ahead of the money curb. But what about retirement? While it seems a little strange for many to think that a 15-year-old might begin saving for retirement, it can provide an enormous benefit for your child later.

Anyone with earned income can open an Individual Retirement Account (IRA) and start investing [4]. With children, the IRA will be custodial, meaning you are in charge of it until your child reaches the age of majority (check your state law to see when this is). The assets in the brokerage account [5], though, are your child’s, not yours, so keep this in mind.

What is Earned Income?

In order to open an account in your child’s name so that he or she can contribute, your kid has to have earned income. Here are some examples of what constitutes earned income:

It is important to note that allowance is not considered earned income. Additionally, interest received on savings accounts, and gains from investments in the child’s name, are not considered earned income.

Contributing to a Child’s IRA

Regular contribution limits apply to any IRA [6] opened in your child’s name. Many parents like to go with a Roth, since a child’s income now is not likely to be large enough to result in taxes, so contributing “after tax” dollars is of benefit, since they will grow tax free.

The main limitation on child IRAs is that the child cannot contribute more than he or she made in a year. So, if your child only earns $1,500, that is maximum that can be contributed to the account. If your child earns more than $5,000 (more likely for teens), then it is possible to max out the IRA. You can contribute on your child’s behalf, but the same contribution limits apply: Max IRA contribution or amount your child earns, whichever is lower.

Opening an IRA for your child can be a great way to get the ball rolling, and help him or her get off to the right retirement start.

(Photo: Howard County Library System [7])