Two Ways to Start a Roth IRA for Your Child

Setting up a Roth IRA for your child enables you to gain extra time for tax-free growth on your contributions before they even leave the nest. Time is the most critical factor in investing, so buying your child a few extra years for saving will set them up for financial success. 

Opening A Roth IRA

There is no age limit for opening a Roth IRA account. However, having earned income is what makes your child eligible. Earned income can be any wages, salary, or tips collected from work. The money earned can come from a W-2 or a self-employment job like babysitting.

These account types have an annual contribution limit of $6,500, but are capped by the earned income amount for your child. Whichever is the lesser of the two is how much you can contribute to the IRA account.

For example, if your child had a summer job where they made $2,000, as their parent, you could put up to $2,000 in a Roth IRA for them. You would be unable to put more than $2,000 in the account for the year because they did not make more than that from their job.

Rollover a 529 Plan

Deciding how much to put into a college savings account is a difficult decision. The accounts are strategically funded, and you often have to consider factors like your child not attending college or receiving scholarships. Traditionally, if the money is not utilized for education expenses, having unused funds in the account would result in taxation. 

With the Secure Act 2.0, that problem has been alleviated by allowing 529 Plans, an investment account that offers tax-sheltered benefits to pay for qualified education expenses, to be rolled over into a Roth IRA. Starting in 2024, any unused funds in a 529 plan can be rolled over into a Roth IRA in the beneficiary's name. 

For example, let’s say you started a 529 plan for your daughter on her fifth birthday. In total, you have contributed $150,000 to the account. She is now graduating at 22 and only used $145,000 from her account for education expenses. You can now rollover the remaining $5,000 into her Roth IRA. Read more about the benefits of a Roth IRA for education savings.

Restrictions to Rolling Over a 529 Plan

1. The account has the same contribution limit as other Roth IRA accounts. It will be capped at a $6,500 annual contribution.
   
   
2. There cannot be more than a total of $35,000 rolled over from a 529 plan in the account’s lifetime.
   
   
3. The 529 plan must be at least 15 years old before rollovers begin.
   
   
4. Before rolling over into the Roth IRA, contributions in the 529 plan must be at least five years old.

Benefits of Starting a Roth IRA Early

In addition to the added years of investment compounding, starting a Roth IRA for a child starts the Roth 5-year rule early. The 5-year rule with a Roth IRA is a provision that restricts the tax-free distribution of any earnings, contributions, or converted balances (a 10% early withdrawal penalty may still apply depending on the account holder’s age).

As with all Roth IRAs, contributions to the plan can be removed from the account at any time without penalty. 

Should the child account holder be a minor, the parent would have oversight over the account and the freedom to direct the account’s investments into a wide array of investment options. 

Midland can assist you with setting up your child’s Roth IRA. Visit our website or call (239) 333-1032 for more information.