There are only two kinds of individual retirement account (IRAs) that a child can open for them: Traditional and Roth Ira for kids. There are many differences between a Traditional IRA and a Roth IRA, but hopefully, in short, here is the big takeaway:
A Traditional IRA is designed to provide a steady stream of money to its members who meet the age requirements. For people who are younger and have yet to reach the age required to receive a tax-deferred retirement benefit, a Traditional IRA has several advantages. First, it provides much-needed protection from inflation by allowing contributions to grow tax-deferred. The tax deferral also acts as a safety net in case any unexpected circumstances lead to an immediate withdrawal of funds.
But if you want your child to contribute to a Roth IRA in order to save for their retirement, then you’ll have two ways to do it. One way, of course, is for them to individually roll over their employer-sponsored retirement plan into a Roth IRA for kids. In most cases, this is done via the employer. However, to take advantage of the tax-deferred growth benefit, the employee must begin taking withdrawals from the account at the age of 10, which can be a bit of a challenge during the early years of adulthood.
In addition, some people choose to get their children involved with the more traditional forms of IRAs. These would be the 401(k)s and IRAs. Although these types of retirement accounts also tax pre-tax dollars, unlike Roth IRA, they provide a much more attractive way for kids to contribute to their retirement savings vehicle. The Roth IRA allows a child to take regular deductions for their earnings. On the surface, this seems like a bad thing, but there are good reasons for this.
First, a kid is much less likely to withdraw money before they reach retirement age because of the tax-free status of these contributions. Second, the contributions to these types of retirement vehicles grow tax-free, just as investments in traditional IRAs do. If the contributions become too large, though, the tax-deferred growth effect can cause a significant increase in the amount of money accumulated through the account. The Roth IRA does not have this issue.
Another way to get your child involved with your Roth IRA is to encourage them to start investing early. If they are old enough, your kids can start taking online stock market courses to learn how to invest. A good investment strategy starts young. There’s no better time to teach your children about Roth IRA for kids contributions than while they are still young. You can give them specific guidance on how to save for retirement, but you and they should also talk about the best ways for you to spend the money that they’ve saved. At that point, you can both discuss what you would do with the money if it was not tax-deferred and whether the investments would be better made in stocks, bonds, real estate, or other alternatives.
You can also help your kids understand the differences between Roth IRAs and traditional IRAs. In particular, you might want to explain why it is not wise for your child to contribute funds to a Roth IRA based on their current tax situation. Keep in mind that IRAs’ earnings and distribution tax rates are different from the tax rate for Traditional IRAs. You may want to also explain to your kids the difference between Roth IRA and a traditional IRA, as well as the different tax benefits that come with the Roth IRA. While most people think of the Roth IRA as a vehicle for investing for the wealthy, it is not recommended that your kids contribute to this type of IRA if they do not have the means to do so.
When you are working with your child to make sure that they understand the benefits of Roth IRA contributions, you might also want to let them take part in some early retirement planning. The IRS allows taxpayers to make contributions to their IRAs up to age 50. In addition to allowing your child to contribute to an IRA, you can also allow him or her to take advantage of tax-free withdrawals. A tax-free withdrawal allows a taxpayer to take out whatever amount they want from their IRA account without paying taxes on the withdrawal. However, you should make sure that your child understands the rules of the IRA and tax deductions before permitting him or her to take a tax-free withdrawal. You can contact IRS Help Attorney for more information. Your kid can learn more about Roth IRAs and tax deductions by enrolling in a class run by a retirement care provider or via the Internet.