Building Wealth from a Young Age: A Guide to Contributing to an IRA for Your Children

In today’s world, one of the best gifts you may give your child is financial security. While education and values play key roles in shaping their future, contributing to a custodial Individual Retirement Account (IRA) for your child’s benefit may serve as a powerful tool to help instill the importance of saving and planning, inspire financial responsibility, and set the stage for building lifelong wealth.

Why Start Now?

Long-Term Compounded Growth

One of the most compelling reasons to open an IRA for your child is the power of compound interest. By starting at a young age, your child’s investments have the potential to grow over time. To put it in perspective, if one contributes $5,000 per year for thirty years and achieves a 7% compounded rate-of-return over that time, that will amount to nearly half a million dollars in future retirement savings. This long-term growth may provide your child with a substantial advantage in building wealth.

Establishing a Nest Egg

Opening an IRA for your child helps establish a financial nest egg early on. While an IRA is intended for retirement savings, it also provides a safety net that your child may rely upon in their adult life. This foundation may also help alleviate potential financial stress as they make important life decisions, such as buying a home or starting a family.

Teaching Kids About Finance

Contributing to an IRA also provides an opportunity to educate your child about finance. By involving them in the process, you may teach them the basics of investing, the importance of saving, and the benefits of long-term planning. These invaluable lessons should help foster financial literacy from a young age, a foundation of knowledge they may build upon in the future.

How to Get Started

Eligibility Requirements

In order to contribute to an IRA your child must have some type of earned income reported to the IRS. This could be W-2 income from a part-time job, like working at a grocery store or golf course, or perhaps self-employment income from babysitting, dog walking, or providing lawncare services. Some families may also choose to hire their kids into the family business.

Choosing the Right IRA

The two main types of IRAs to consider for your child are a Traditional IRA and a Roth IRA. For tax planning purposes, the Roth IRA is often recommended because it offers the power of tax-deferred growth and qualified withdrawals are tax free. Children are also usually in the lowest tax bracket which makes the tax-deductible contribution of a Traditional IRA less attractive when compared to the potential tax-free compounded growth of a Roth IRA.

Contribution Limits

The contribution limit in 2024 for a custodial IRA is $7,000. You may contribute any amount up to your child’s earned income or $7,000, whichever is less. For instance, if your child earned $5,000 then they could contribute any amount up to $5,000. If they earned $10,000, then they could only contribute up to the maximum limit of $7,000.

Setting Up the Account

To set up an IRA for your child, you’ll need to choose a brokerage firm that allows custodial accounts. These accounts are opened in your child’s name, with the parent serving as the custodian until the child reaches the legal age of majority (usually 18 or 21 depending on the state of residence). It is important to research and compare fees, investment options, and account features before choosing a provider.

Conclusion

Contributing to an IRA for your child is a forward-thinking strategy that offers numerous advantages – from establishing a strong financial foundation to teaching valuable financial lessons. By starting early, you are not just investing in your child’s financial future, but you are also instilling a sense of personal responsibility and financial intellect. To learn more about how you can get started, consider working with a qualified financial advisor who may help guide you through the process.


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