Building wealth for your child with a Custodial Roth IRA

[UNITED STATES] A Custodial Roth IRA can be a powerful financial tool to help parents and guardians set their children up for a secure future. By opening an account on behalf of a minor, individuals can take advantage of tax-free growth, building wealth for a child that can last a lifetime. The benefits of this retirement account—traditionally a strategy for adults—are now available for younger investors, giving them a head start on a financial journey that will have lasting impacts on their retirement readiness and financial independence.

A Custodial Roth IRA is a retirement account that is managed by a parent or guardian on behalf of a child under the age of 18 or 21, depending on the state. Unlike traditional savings accounts or investments, a Roth IRA allows contributions to grow tax-free, and withdrawals made in retirement are also tax-free, provided the account has been open for at least five years and the individual is over the age of 59½.

This unique arrangement allows parents to introduce their children to the world of investing at a young age, giving them the opportunity to take advantage of the time value of money. While the primary purpose of the Roth IRA is retirement savings, there are other potential benefits, making it a highly flexible financial planning tool.

Eligibility Criteria and Contribution Limits

To open a Custodial Roth IRA, the child must have earned income. This means they need to have a job or business that provides them with taxable wages or self-employment income. Common examples of eligible work include babysitting, tutoring, acting, or even working a part-time job in retail. The key point is that the income must be verifiable and reported on the child’s tax return.

For 2025, the IRS allows contributions of up to $6,500 per year or the amount of earned income, whichever is less. This limit is subject to change annually to keep up with inflation. If the child earns more than $6,500 in a year, they can contribute the full $6,500; if they earn less, the contribution limit is restricted to their total income for the year.

Why Start a Custodial Roth IRA for Your Child?

There are several compelling reasons why parents should consider a Custodial Roth IRA as a long-term financial strategy for their children:

1. Tax-Free Growth

The most attractive feature of a Roth IRA, whether for an adult or a child, is its ability to provide tax-free growth. The contributions you make to the account are after-tax, but any earnings—such as dividends, interest, or capital gains—are not taxed when withdrawn after retirement. Over time, this can result in a significantly larger nest egg for the child.

2. Early Start = More Growth Potential

Time is one of the most important factors in building wealth. The earlier a child begins saving and investing, the more their money can compound. By starting a Custodial Roth IRA as early as possible, parents give their children the advantage of decades of tax-free growth. This early start can help ensure that their child’s retirement is financially secure.

3. Flexibility in Future Withdrawals

While Roth IRAs are designed for retirement, they offer flexibility for other life events as well. If a child needs funds for a first-time home purchase or educational expenses, they can withdraw their contributions (not the earnings) at any time without penalty or taxes. This makes the account somewhat versatile, offering a balance between long-term retirement savings and more immediate financial needs.

4. Teaching Financial Responsibility

Opening a Custodial Roth IRA is an excellent opportunity to teach children about money, investing, and the importance of long-term planning. It allows parents to introduce basic financial principles, such as saving, compounding interest, and responsible investing. These lessons can pay off not only in their retirement accounts but in their broader approach to personal finances.

Considerations and Potential Drawbacks

While Custodial Roth IRAs offer significant benefits, there are a few considerations to keep in mind before opening one for a child:

1. No Access to Earnings Until Retirement

Although contributions can be withdrawn at any time, the earnings in the account must remain until the child reaches retirement age. This means that if the child needs the money before they are 59½ and the account has earned interest, those earnings would be subject to taxes and a 10% early withdrawal penalty.

2. The Custodian's Control

The custodian—typically the parent or guardian—has control over the account until the child reaches the age of majority (usually 18 or 21). This means parents are responsible for managing the account and making investment decisions. Once the child reaches the legal age, they gain control of the account, and the custodian’s role ends.

3. Limits Based on Earned Income

The Roth IRA can only be funded with earned income, which may be limited depending on the child’s job. If a child is not earning a significant income, the amount that can be contributed to the account will be limited.

How to Open a Custodial Roth IRA

Opening a Custodial Roth IRA is relatively straightforward. Here's what you’ll need to do:

Choose a Custodian: The first step is to choose a brokerage firm or financial institution that offers Custodial Roth IRAs. Many major brokerages, such as Vanguard, Fidelity, and Charles Schwab, offer these accounts with low fees and access to a range of investment options.

Provide Documentation: You will need to provide personal information about the child (including a Social Security number) and verify their earned income. The parent or guardian will also need to provide their own details to establish the custodial account.

Fund the Account: Once the account is open, you can begin making contributions. Keep in mind the contribution limits and ensure the child has earned enough income to justify the contribution.

Start Investing: Once funded, the account can be invested in a wide range of assets, such as stocks, bonds, or mutual funds. The key is to select investments that align with the child's long-term financial goals.

A Custodial Roth IRA is an excellent way to give your child a financial head start and to take advantage of the power of compound interest and tax-free growth. By starting early, parents can help their children build significant wealth for retirement, while also providing a valuable opportunity to learn about personal finance. With the right strategy, a Custodial Roth IRA could be one of the most impactful financial tools for a child’s future success.