Surprise! Your Kid’s Summer Job May Qualify Them for Their First Roth IRA
Although retirement planning may be low on the to-do list for kids, it can help kids get a head start on their financial goals. Time can be your kid’s secret weapon for financial success and help them build a million-dollar Roth IRA (individual retirement account).
As good as this wealth-building goal sounds, your child has to meet some requirements to qualify. Fortunately, your child’s summer job may be exactly what they need to unlock this retirement planning opportunity. Since age is not a barrier to contributing to a Roth IRA, your child can start on the path to retirement success as soon as they start making money.
Let’s talk about the Roth IRA rules for kids
Minors typically can’t open a Roth IRA in their own name, so they’ll need an adult to assist them in this process. An adult has to serve as custodian of the account until the kid is legally able to do it on their own. The custodian will make decisions about contributions, investments, and withdrawals until their kid turns 18.
Although you don’t have to worry about age restrictions, you will need to make sure your kid checks the box on the earned income requirements to qualify for a Roth IRA. Here’s what you should know about earned income:
- Your kid’s income can’t exceed the annual threshold. This typically isn’t an issue for kids because their income usually falls in the lowest tax bracket. For 2022, the IRS income limit to make a Roth IRA contribution is $144,000 for single tax filers.
- If you are contributing money to a Roth IRA on your kid’s behalf, your contribution can’t exceed your kid’s earned income for the year. For 2022, you can contribute up to $6,000 to a Roth IRA. But if your kid only earned $2,000 this summer, you can’t contribute more than $2,000 to your kid’s Roth IRA.
- Make sure your child’s income counts as earned income. This would include wages, salary, tips, and self-employment income. If your child earned interest and dividends during the year, that doesn’t count toward the earned income requirement.
If you have any questions about contributing to your child’s Roth IRA and reporting income for tax purposes, it’s important to reach out to your tax professional. Documentation and reporting are key pieces of the Roth IRA process for kids.
Turn your kid’s summer job into a wealth-building opportunity
Having the opportunity to build a million-dollar Roth IRA may sound unrealistic if you don’t know how to get started. But the first goal on your journey is to make sure your child has earned income. That can come from mowing the lawn, modeling gigs, or summer jobs as long as it’s all documented correctly.
While some of the money your kid earns can go to the piggy bank, another portion of the money can be set aside for their future.
Let’s say you start setting aside $6,000 for your 15-year-old daughter who earned $8,000 from acting and modeling gigs in the summer. If the account continues to be funded with $6,000 annual contributions, and the money is invested in high quality assets, your child could become a millionaire before retirement (assuming a 7% annual rate of return).
Although specific returns aren’t guaranteed, time will give your kid a chance to grow their money over the long-term and make up for any market downturns.
It’s important that you also teach your child the importance of patience and discipline. If your child touches any of the earnings accumulated in the account before they are eligible to do so, they will be on the hook for an early withdrawal penalty.
On the bright side, your child can have a chance to build a $1 million Roth IRA by starting early. All the money in the account should be 100% tax and penalty-free after they turn 59 1/2. With a Roth IRA, you pay the taxes on the money up front — while your child is in a lower tax bracket — in exchange for tax-free growth and withdrawals during retirement.
Don’t let your kid’s summer job go to waste
Your kid’s summer job can help them gain valuable skills and earn a paycheck. But if you want your child to have financial success over the long term, it’s important to teach them about saving and investing as soon as they start earning money. A Roth IRA can help you jump-start that conversation with your child and position them to build a million-dollar nest egg before retirement.
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