Money Talks, So Should You

Q&A: How can I start an IRA for my child?

Lydia Palmin
by Lydia Palmin, The Garrett Network  (@BhutaniPalmin)

Starting an IRA for your child is fairly straightforward.

First, determine if they are qualified:
• They need to have earned income that is at least equal to the IRA contribution, and can contribute up to $5,500 for 2013 ($5,000 for 2012).  

• If they are employed at a business, they'll receive a W-2 showing earned income, but they can also use income earned babysitting, mowing lawns, etc.

Check with your tax advisor regarding how best to document income and whether you need to file a return for your child.

READ: Here's how to teach your child to save and budget

Second, decide what kind of IRA to fund – traditional or ROTH IRA:
• Most children will not earn enough to pay much (or any) income tax, so the up-front benefit of a traditional IRA – the contribution is tax deductible – is minimal at best.

ROTH IRA contributions are not tax deductible, but earnings on those contributions grow tax-deferred, and if withdrawn after age 59 ½, will be tax-free. Contributing to a ROTH IRA early in life, when added to the power of compounding returns, can add up to a nice nest egg for your child at retirement.

• Also, the contributions to ROTH IRAs are available for withdrawal with no penalty (since they were not tax deductible); only the earnings on those contributions are subject to taxes and penalty if withdrawn early.  

READ: What is often overlooked when planning for college?

Third, open the account:
• Since your child is a minor, the IRA will be opened as a custodial account.  Direct control of the account transfers at age 18, or age 21 in some states if chosen at the time of opening.  

• Indicate the tax year for which you're contributing on the check; if it's for the previous tax year, make sure to fund the account before April 15th of the current year.

No one plans to fail; they just fail to plan.

 

Tagline Logo

Lydia Palmin has practiced the profession of financial planning since 1997 and co-founded Bhutani-Palmin Financial Planning, a fee-only, hourly practice, in 2006. A Certified Financial Planner practitioner, she holds an MBA from the University of Southern California and a BA from the University of California, Berkeley.