T. Rowe Price Personal Investor - How a Custodial IRA Can Help Your Child With Future Retirement Savings (2024)

FAQs

What are the benefits of a custodial IRA? ›

All funds in the account belong to the child, allowing them to start saving money early. In addition to reaping the benefits of compounded growth, your child may be able to use the funds for future expenses like college tuition or even to buy a first home.

A contribution to a custodial Roth IRA for Kids can be made if a minor has earned income during the year. Eligible income can include formal employment income or self-employment income. Activities like babysitting or mowing lawns can qualify a minor for Roth IRA contributions.

If you manage a custodial IRA for your child, they will assume complete control over the account when they turn 18 (or 21 in some states). This means they are free to continue contributing, or they can liquidate the account to pay for their first home, college tuition, or any other expense.

In general, the Roth IRA is the IRA of choice for minors who have limited income now. By the same logic, it's often recommended for adults who expect to be in a higher tax bracket in the future. "If a child keeps [a Roth] until age 59½ (under today's rules), any withdrawal will be tax-free.

You can open a custodial brokerage account at a bank or brokerage firm. A custodial account can be a great way to save on a child's behalf, or to give a financial gift. Basically, these are easy-to-open accounts used to invest in stocks, bonds, mutual funds, and more, all to give your child a better future.

Tax Limitations: Custodial accounts have some tax advantages (and no penalties), but 529 plans offer more tax savings overall. Gifts Are Irrevocable: There are no takebacks—even if you need the money or want other children to share in the account assets.

A custodial account is a great way to give minors cash, securities and other investments. That said, keep in mind the tax and financial aid implications and the fact that withdrawals must be used for the benefit of the minor.

A portion (up to $1,250 in 2024) of any earnings from a custodial account may be exempt from federal income tax, and a portion (up to $1,250 in 2024) of any earnings in excess of the exempt amount may be taxed at the child's tax rate, which is generally lower than the parent's tax rate.

Certain qualified distributions² of earnings and contributions — including a lifetime limit of up to $10,000 used to pay for a first-time home purchase — become federal income tax free five years from the beginning of the year in which the custodial Roth IRA was established (state and local taxes may vary).

Both Roth IRAs and custodial Roth IRAs are funded with post-tax money. This setup means that your contributions can always be withdrawn at any time, tax-free and penalty-free. Earnings on the account, however, will be subject to penalty and taxes, if taken out before age 59 1/2.

How do I save money for my child? ›

When a beneficiary reaches the age of majority (21 in most states), the custodian must turn the account over to him or her. At that time, the beneficiary will become the owner of the custodial account, controlling all of its assets.

Ideally your child should have a W2 or a Form 1099 to show evidence of the earned income. However, there are some instances where this may not be possible so it's important to keep records of the type of work, when the work was done, who the work was done for and how much your child was paid.

Individual retirement accounts cannot be gifted during the owner's lifetime. Once funds are withdrawn from an IRA, they are generally taxable. But funds outside of IRAs can be used to beef up retirement savings for children, grandchildren, and even parents, and can be done free of gift tax.

You can control how the money is invested with many choices available to you while your child is still a minor. You also have flexibility in terms of how the money is spent as long as it's used for the benefit of the child. The drawbacks: You can't change the beneficiary of a custodial account once it's established.

This setup means that your contributions can always be withdrawn at any time, tax-free and penalty-free. Earnings on the account, however, will be subject to penalty and taxes, if taken out before age 59 1/2. With traditional IRAs and traditional custodial IRAs, money goes in pre-tax, and is then taxed when withdrawn.

A portion (up to $1,250 in 2024) of any earnings from a custodial account may be exempt from federal income tax, and a portion (up to $1,250 in 2024) of any earnings in excess of the exempt amount may be taxed at the child's tax rate, which is generally lower than the parent's tax rate.