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  • Writer's pictureBridget Sullivan Mermel CFP(R) CPA

Roth for Kids and Grandkids | Making it Easy and Legit!

Kids benefit from Roth, just like grownups do. Children benefit from Roth can be great places to save money and it can be especially useful to start at early ages. In today’s episode learn how you can fund a Roth IRA for your children who are under age 18, what the rules and requirements are for kids to have Roth IRAs and what kind of access they will have to that money.

We'll also compare Roth IRAs for kids to 529s and I Bonds. We'll also discuss how to use Roth IRAs to help teach your child or grandchild about saving, money, and investing.

Major points include:

• Kid needs to have earned income

• Money put into the Roth does not need to be the kids own; i.e., parents/grandparents can fund it up to earned income

• Rules are like for any other Roth…principal can be taken out tax & penalty free at any time; gains can be taken out taxable but no penalty for college

Make sure to watch to the end when we talk about the drawbacks of giving Roths to kids and grandkids!

00:00 Welcome

00:55 How Roths work

01:43 First Qualification

03:10 Roth IRA limits

03:55 Drawbacks

04:20 Where does it make sense

04:39 Roth IRA vs 529

07:02 Roth IRA for kids vs I-Bonds

08:50 Another opportunity with Roths

09:57 Matching what kids put in

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Thanks for watching and please subscribe!


John: Roth IRAs can be a great place to save money. And the earlier you start, the better off you are. In today's episode of Friends Talk Financial Planning, we're going to talk about how you can have Roth IRAs set up for your kids and grandkids who are under 18. And by the end of this episode, you're going to know what the rules are for setting those up, how to fund them, and what the drawbacks and the pros are of that and how you might implement this in your situation. I'm John Scherer, and I run a fee-only financial planning practice in Middleton, Wisconsin.

Bridget: And I'm Bridget Sullivan Mermel, and I've got a fee-only financial planning practice in Chicago, Illinois. And John, before we jump into Roth IRAs for kids, we want to remind people to please subscribe. It helps us with YouTube credibility. All right, so John.

John: Into Roth IRAs. And we've done episodes before on Roth, but just as a big picture, so I think it might be useful to talk about why Roth IRAs? Money goes into the Roth IRA. There's no tax benefit. No deduction. When it grows, however, there're no taxes, and when the money comes out for retirement, there’re typically no taxes, so all tax-free growth. That's sort of the secret sauce to these things.

Bridget: Right.

John: And then we get questions in our office about, now I've got my child is 14 or 16 or 18 and they're starting to make some money. And I know this Roth IRA thing is really good. Can we do a Roth IRA for the kids? And the answer to that is yes. Actually, we get that question a lot of times: “Hey, my kid's 14; can I do a Roth IRA for them?” And the answer is yes, but there're some qualifications. And I think we've identified either three or four different qualifications. The big one that we have to have across the board is the kid has to have earned income.

Bridget: Exactly. They have to be making some money.

John: Right. So if my 14 year old does not have a job, I can't just put money into a Roth IRA for her. It doesn't work that way. You have to have earned income. What do you mean when you're talking about earned income, though?

Bridget: Well, it's got to be on the books; it can't be under the table. It's got to be above the table.

John: I love that. “Above the table.” It's exactly right, though. We think, “Oh, yeah, he babysits, she babysits, they got a paper route,” those sorts of things. If you're just getting cash, that doesn’t count. We pay our babysitter in cash, that money is not taxable as income to them, because they're under the limits.

This is not like we're doing shenanigans by paying our babysitters things, but it also isn't reportable as income. There are ways that you could maybe keep track of that, but the easy things are when your child gets their first job: when they're working at McDonald's or wherever kids are going to work these days; maybe they work at the grocery store.

Bridget: I used to caddy.

John: Nice. I caddy on the golf course, so I'm getting a paycheck. And at the end of the year, just like everybody gets their W-2s for their regular full-time jobs, you get a W-2. If your child has a W-2, the number in there, which is usually the same in boxes one, three and five, on the W-2 that you get a tax time, that's the amount of money that you can put into a Roth IRA. Now, the Roth IRAs have limits just like regular IRAs do. You can't put $25,000 into them.

Bridget: Right.

John: There're limits as to what you can put in. So you can put in up to that limit of IRA contributions, but also it's limited by how much you earn. If your child or grandchild earns $500, you can put $500 into a Roth IRA. If they make $1,000, you can put $1,000 in—up to that cap. In a lot of cases, we'll have parents and grandparents that say, “Well, listen, my grandchild made this much money last year; can we fund a Roth IRA for them?” Absolutely. Let's make that gift.

One of the drawbacks to this is we got to keep in mind that this is a gift to kids. This is not some way that you can save money over here in this left-hand pocket and kind of sneak other cash around, saying, “I'll fill up my Roth IRA and do theirs.” No, you're making a gift to the child. So does this come in place of your retirement savings? No. What happens if you don't have enough of an emergency fund built up yet? No.

With all those things that play a factor, where does it make sense. Maybe where grandma and grandpa would like to make a gift to the kids, or you say, “I'd like to give money to the family.” Mom and dad say, “Listen, we've got extra money. We're filling up our IRAs. We're filling up our Roth 401Ks. We've got some extra money in a brokerage account. Geez, some of that money is going to go to the kids anyway.” Roth IRA can be a great place for that.

Bridget: Okay, so let's talk about Roth IRAs versus other savings vehicles. For example, Roth IRA versus 529. What are your thoughts?

John: It's similar, but maybe different kinds of apples. 529 plans need to be used for higher education. And think about what's the benefit of a 529 plan. You put money in, and then when it grows, if you take it out for college or other school, you don't have to pay taxes on the growth.

Bridget: Right.

John: So that's the real magic sauce to the 529 plans. So those are a great deal, they totally make sense, but it's not like there's some magic. Sometimes people think, “Oh, I need to put money into my 529, so I can pay for college.” No, it's not just that. And think about who we're talking about here with these kids that are eligible for Roth.

What's the one major factor: they need to have earned income? Who has earned income? Not your five-year-olds and probably not your nine-year-olds either. Once you get to some level: 10 years old or 12 years old. Hey, now, if I'm a 14-year-old, how much runway is there before I’m going to need to use that money if it's for college: three, four, five years. Not that it's wrong to do 529, but the bang for the buck is less, because all we're doing is getting the growth that comes out free.

So as you look at that, it's not like 529s, in my opinion, are wrong, but it's about asking, “What's the delta on that? What's the difference?” And oftentimes there's already money that's set aside when people are saying, “I want to give money to the grandkids” or “I want to give money to the kids.” Many times, they've already done college savings.

Bridget: Right.

John: And even if they haven't done that, you go, “What's the difference in having a few years of growth tax free?” The Roth can be a good place for that, in my mind, anyway.

Bridget: Right. With a 529, you have more control over it, so if the child doesn't use it for education, then you can use it for another child. So it's not a pure gift like the Roth is.

John: And the other thing—you bring up a great point—is that I can open up a 529 for my child, but I still control that. They're the beneficiary, and I can give it to a sibling or a cousin, but it's not my kids money.

Bridget: Right.

John: If the money goes into a Roth IRA, however, once they get to be adults, the money is theirs, so you have to factor that into your thinking on things.

Bridget: Absolutely. What about Roth IRA versus I bonds?

John: Well, that's a great thing. We love I bonds. I mean, it's a great interest rate, but now we're sort of talking apples and oranges. And again, we're talking about something that's in a retirement plan that can grow tax free…

Bridget: …which is a Roth.

John: Right. I bonds, however, are in a taxable category, so they're taxable investments that will grow with an interest rate. An I bond is an investment, while a Roth IRA is a tax bucket that holds investments in it.

Bridget: Right.

John: So it really is sort of two different things. And I'll go back to what we talked about at the beginning. If it makes sense for you, mom and dad or grandma and grandpa, to have an I bond in your portfolio, then do that. If it makes sense for your situation to gift money to your grandkids, doing the Roth IRA is one of the leading opportunities for that. Do you think any differently on that, Bridget?

Bridget: No. So it sounds like you like Roth IRAs over I bonds if you really want to gift to the kids, right?

John: Yeah. And not that it's wrong to gift an I bond to the kids. Not at all. But think about this again. Let's assume they're 14 or 15-year-old teenagers. What's their time horizon? Saving money for long-term, putting $1,000 away today, and it grows and grows over 20, 30, 40, 50 years, and all that growth comes out tax free relative to buying an I bond, which right now has really great interest rates, but of the last decade or so, it did not have very good interest rates. Listen, those tax advantages seem to make sense to me, but it's one of these things to analyze, to know what's the difference and take a look at those and make it your own decision. But I really favor the Roth.

Bridget: Yeah. And I would say if you do the Roth gifting strategy with your kids or grandkids, that it's a good opportunity to engage and say, “Okay, here's a brokerage account. Now we can invest it in different things. How should we invest it? What should we do?” And get them involved. I'm sorry to jump on top of your Bridget, but we literally just had a client in the last two weeks.

He asked, “Listen, my child is 17 years old. I'd really like to get him interested in investing. He's got some money saved up. What do we do? What can we do? Can we open a brokerage account to teach them things?” Yes, you can. If he's got some earned income, why don't we set it up in a Roth IRA? We're going to teach those same things, and yet it's going to be tax deferred and all these tax advantages. It's an exact situation.

Bridget: Yeah. And the kid can probably open it up on their phone.

John: Exactly. And the other thing that I want to just point out is that if my child earns $1,000, they don't have to put the $1,000 into the Roth IRA. I can write a check. The IRS doesn't care where the money comes from. What they care about is, is there earned income. Was there earned income that gets reported and shows up on a W-2? If yes, then I can do that, then grandma and grandpa can make that contribution.

We’ve had some people that have said, “I don't want to just give my kids this money or my grandkids this money. I want to instill in them the idea that saving is good.” So what we'll do something almost like a 401K match sort of a thing: “If you put in $100, I'll put in $500. For every dollar you put in, I'll put in five. For every dollar you put in, I'll put in $10. But if you don't put anything in, you don't get this extra money.” This can be a really good place for teaching the habits as well that doesn't have anything to do with the IRS or technically what happens but how somebody practically deals with that.

Bridget: And again, encouraging engagement helps to increase your bond with your child and grandchild.

John: That's right.

Bridget: So with that, I think it's a great way to call it. My name is Bridget Sullivan Mermel, and I've got a fee-only financial planning practice in Chicago, Illinois.

John: And I'm John Scherer. I've got a fee-only financial planning practice in Middleton, Wisconsin. Both Bridget and I are still actively taking on new clients, so we're happy if you reach out, but we're also members of the Alliance of Comprehensive Planners. If you like what we talk about, and you’re looking for a planner that thinks similarly, who might live in your area, check out

Bridget: And please, subscribe.

At Sullivan Mermel, Inc., we are fee-only financial planners located in Chicago, Illinois serving clients in Chicago and throughout the nation. We meet both in-person in our Chicago office and virtually through video conferencing and secure file transfer.

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