Roth IRAs for Kids
This article is for Sida, one of QVC's viewers in California who wanted to know about Roth IRAs for kids.
Starting in 1998, a new kind of IRA, called a Roth, came on the scene, and at the time my advice to everybody was: If you qualify, get one. It still is. The Roth is an especially wonderful way for those of you who have kids and who want to save for college to do so, but you can also save for a home of your own or for retirement down the road. Let me explain.
A Roth is different from a traditional IRA. How? If you want a detailed explanation please see the ASK SUZE book on Planning for your Future, pages 22-35. But for those of you who I know won't go to the book to look it up, this is how they work.
The money you contribute to a Roth (up to a maximum of $2,000 a year per person if you meet certain income qualifications) isn't tax deferred. Up front, your contributions are treated just like the money you are putting into any of your non-retirement investment accounts; in other words, you must pay income taxes on the money before investing it. (With a traditional IRA, the money you contribute isn't taxed until you withdraw it at retirement.) So what's the big advantage? There are lots of advantages to a Roth, but the biggest one is that you can withdraw both your money and earnings tax free. If you are 59.5 or older and those funds have been in the Roth for at least five years. With a regular IRA, you pay taxes on your earnings as well as contributions when you start taking your money out.
Second, you don't have to wait until you're 59.5 to withdraw any of your original contributions to a Roth account; you can take out your own money any time you want, for any purpose, without paying taxes or a penalty, because it's already been taxed. It is only the earnings on that money that have to stay in the account for five years and until you are at least 59.5 years of age.
Third, your money, both your contributions and your earnings, can be withdrawn without any penalty regardless of how old you are or how long those funds have been in there IF the money is used for certain specific purposes. These include paying for college or graduate school and using up to $10,000 to buy your first home.
Even though the Roth is a great deal for anyone who qualifies as a way to save for retirement, the main reason for this article is for those of you who have kids or grandkids. If they are old enough to work, even just around the house or at your office, the Roth IRA is especially attractive, because kids' tax bracket is usually very low or nonexistent. The reason I said "if the kids are old enough to work" is that all money that is put into a ROTH IRA must come from kids' own earned income. It can't be money that is a gift or is earned from dividends or interest or from any other investment. If your child is old enough to earn some money by doing odd jobs, then that can go into this Roth.
Let me show you why you are going to wish your parents could have helped you do this, and why you should help your kids or grandkids to do it. Let's say your child does some paid chores after school and that she earns $166 a month. If she starts working at age 8 and every month puts her $166 into a Roth IRA that invests in a good no load mutual fund with an average 11-percent rate of return, at the age of 17 she would have a total of about $30,000 in that Roth. (For more about no-load funds, see the ASK SUZE book on Mutual Funds and Annuities, page 39). Of that $30,000, $18,000 can be taken out take tax- and penalty-free for any purpose, because that's the amount she contributed over the years. The additional $12,000 is considered earnings; but if the child uses that money for education, she can also withdraw the $12,000 penalty-free, without waiting until she reached the mandated age of 59.5. She will have to pay taxes on that $12,000. But she could use just the $18,000, and leave the $12,000 in there to grow until retirement.
In fact, by the time that child is 60, $12,000 at 11 percent a year will have grown into $1,000,000. Not so bad, if you ask me. And if she left all $30,000 in the account to grow and never added another penny, at age 60 she would have about $2.7 million dollars, and she could take it out totally tax free. How happy would any of us be to know that, at age 60, we'll have close to 3 million dollars, tax free, waiting for us? I thought so.
In my opinion, this is something that you can't let your kids pass up. For that matter, if you qualify, you should also open up a Roth.
Where can you open up a Roth IRA in your kids names? There aren't a lot of options, because some mutual fund companies and brokerage firms won't open an account for minors. But other fund and brokerage companies are willing to work around this by having a parent or guardian co-sign the paperwork. Here's a list of large fund companies that are willing to open IRAs for kids:
* Baron, 800-992-2766
* Dodge & Cox, 800-621-3979
* Invesco, 800-525-8085
* Janus, 800-525-8983
* Neuberger & Berman, 800-877-9700
* PBHG, 800-433-0051
* T. Rowe Price (on a case-by-case basis), 800-638-5660)
* Strong, 800-368-1030
* Stein Roe, 800-338-2550
* USAA, 800-531-8722
* Vanguard, 800-635-1511
Please note that mutual funds usually require a minimum investment: $250 at Strong, for example, and $1,000 at T. Rowe Price. But if you want to start smaller, brokerage firms Charles Schwab and TD Waterhouse will open IRAs for kids with no minimum investment and no annual maintenance fee.
So the bottom line is this: The Roth IRA is a here for you to use. For now. Who knows if it will be around in the years to come, after a new President and Congress take office? That I am not sure about, but if you can, it's something that you and your kids should be taking advantage of.
Now you know.
For a great comparison of the advantages and restrictions of Roths and other kinds of IRAs, please go to Smart Money.