Roth IRAs are not typically considered a savings vehicle for kids, but they can be. They are ideal for kids because children have decades for their contributions to grow tax-free. And these accounts offer flexibility, too: Contributions to a Roth IRA can be withdrawn tax and penalty free at any time.
It is worth pointing out that a Roth IRA isn’t just a retirement account. After the Roth IRA has been funded for five years, your child can take out up to $10,000 in earnings to buy a first home, tax- and penalty-free.
Roth IRA earnings can be used for qualified education expenses, like college tuition. Earnings distributed will be taxed as income, but there will be no penalty.
Why a Roth IRA for Kids?
Here are several reasons why a Roth IRA can be a good choice for children:
Retirement accounts have complex distribution rules and may assess a 10 percent penalty on money taken out before age 59 1/2. But a Roth IRA is different. The money contributed can be withdrawn at any time. That flexibility is balanced by tougher rules for the Roth earnings, or the return on contributions that are invested. Distributions of investment earnings may be taxed as income, penalized with a 10 percent early distribution tax or both.
If your child leaves their money in an IRA until retirement, they could be looking at 50 years of investment growth - completely tax-free. For example, a one-time contribution of $6,000 in a Roth IRA, with no additional contributions, would grow to about $200,000 in 60 years (assuming a 6 perecent investment return and monthly compounding).
Savings accounts pay a relatively low rate of interest rate that currently hovers around 0.09 percent.
A Roth IRA allows you to choose investments, which, over the long term, can compound in value; but be beware of an Important trade-off – IRAs that invest in stocks and bonds can lose money.
An IRA for kids works because there’s no tax break for putting money into the account; and as a result, qualified distributions are not taxed.
Talk to your installation’s Personal Financial Management Professional to learn more.
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