How and When To Start a Custodial Roth IRA for Kids

Planning for a child’s financial future is an important part of parenthood. Leveraging the right tools for capital growth and appreciation can help to create a nest egg for college, homeownership and long-term financial stability.

One of the most common savings tools parents can use is the custodial Roth individual retirement account, better known as a custodial Roth IRA, which is designed to grow money tax free. By thinking ahead, parents can help their children understand and appreciate personal finance fundamentals and set the next generation up for long-term savings success.

How the custodial Roth IRA works

The Roth IRA is one of the most popular ways to save for retirement. You can withdraw the money you’ve invested without tax penalty at any point, and once you’re 59 ½ years old, assuming you’ve had the account for at least five years, you can withdraw the earnings tax free. And another bonus of the Roth IRA is that there are no required minimum distributions.

The custodial Roth IRA works the same way, but the parent remains the owner of the account until the child is 18 or 21 years old, depending on which age your state defines as the beginning of adulthood. Once the child reaches adult age, the account converts to a regular IRA, and they are in charge of managing the funds.

Eligibility requirements

Although a child of any age (there’s no minimum age) can contribute to a custodial Roth IRA, there is an eligibility requirement: The child must earn income—and pay taxes on the money.

Of course, the older the child, the more likely they’ll be ready for income-earning opportunities, but there are instances in which very young children, even infants, can make money via modeling or endorsements.

So, if your child is into babysitting, dog walking, mowing lawns, washing windows, or musical gigs, or has a job where they lifeguard, tutor, or work in retail or at a fast-food restaurant, they can contribute to the IRA and take an active role in their own retirement planning.

Annual contribution limits

Children can contribute up to a certain amount per year to a custodial Roth IRA (the limit in 2023 was $6,500). If they earn more than the limit, they can invest that additional amount in a certificate of deposit, savings account or another financial tool. (The IRA contribution limit may change from year to year, so check with a financial advisor.)

Withdrawals and distributions

Because Roth IRAs are designed to be long-term investments, it’s best to let the money grow until you’ve reached retirement age. However, because the money invested in the Roth IRA has already been taxed (remember, the investment is from after-tax income), you can withdraw your contributions at any time without a fee or penalty.

If you want to withdraw the account’s earnings (the amount of money earned from interest or dividends), you’ll have to wait until you’re 59 ½ years old and have had the account open for five years or more. At that time, you can enjoy penalty-free withdrawals. 

Other retirement planning options

While Roth IRAs are preferred for their after-tax benefits, traditional IRAs are preferred for pre-tax advantages. So, while your contributions to a Roth IRA are made after paying taxes on the money you‘re investing, the opposite is true with a traditional IRA: You’re taxed on your contributions when you withdraw the money.

There are other investment options parents can use to help save for their children’s future, including:

• High-yield savings accounts: These accounts typically require a minimum opening deposit and have a low ongoing minimum balance. They’ll offer an interest rate, but it’s typically not as high as the rate you’ll find with a money market account or a certificate of deposit. Many of these accounts also have a monthly maintenance fee.
• Money market accounts: These accounts typically require a minimum opening deposit and an ongoing minimum balance that’s higher than what you’d find with a savings account. However, money market accounts also have fluctuating interest rates that are usually higher than those offered with savings accounts. With a money market account, as long as the minimum balance is maintained, there’s no monthly fee and the funds can be accessed anytime.
• Certificates of deposit (CDs): CDs have a minimum funding amount, a finite term (usually six months or longer) and a set interest rate. The longer the term, the higher the interest rate, and rates are usually higher than those offered with savings and money market accounts. The funds aren’t liquid until the end of the term.

Next steps: Talk with your financial advisor 

When you think about saving for the future, one of the most important variables to consider is growth potential, which means asking, “How much can I grow my money?” Each type of investment tool has its own advantages, so finding the one that aligns with your financial goals is key to longevity and success.

AAA Banking advisors are available to help you plan for your family’s financial future with a custodial IRA, savings account, money market account or CD. And to streamline the process, AAA makes it a snap to apply for, set up and manage your accounts online.

With financial tools like a custodial Roth IRA, you can help your children set the foundation for smart money management that will guide them throughout their lives.