What is a Roth IRA for Kids and How Does It Work?

It's never too early to learn the importance of saving for retirement. If your child has a summer or after-school job, you might consider opening a Roth IRA for kids on their behalf. With such an account, your teen can see firsthand how retirement accounts work, while they take advantage of the benefits of saving early in life. 

Often, young workers owe little, if anything, in taxes for summer job income, so their contributions to a Roth IRA—which are made on a post-tax basis—could potentially be free from any federal taxes. That can make a difference over time, since every extra dollar saved from taxes can be invested for potentially tax-free growth. 

And speaking of growth, starting early allows young savers to make the most of compounding: What they save can potentially generate returns, which may go on to generate additional returns of their own, on into the future. 

Ahead, we'll look at:

• How custodial Roth IRAs work and how to open them
• The benefits of contributing to a Roth IRA at a young age
• Custodial Roth IRA contribution limits to keep in mind

A custodial IRA is an account that a custodian (typically a parent) opens and manages for the benefit of a minor. The barriers to entry are pretty low: These accounts generally have no minimum balance, or account-opening or maintenance fees. (Other account fees, fund expenses, and brokerage commissions may apply.) 

As with any IRA, the owner of the account (the minor) must have earned income to make contributions to the account. The funds invested qualify for special tax treatment, which will differ depending on whether you open a traditional IRA or a Roth IRA. 

The difference between these IRAs for kids is the same as the difference between IRA accounts for adults. 

• Traditional IRAs allow the account owners to make tax-deductible contributions up to a certain limits. Investments in the account can grow tax-free, though withdrawals are subject to ordinary income taxes. Generally, a traditional IRA makes sense for those who will be in a lower tax bracket in retirement than they are today. 
• Roth IRA contributions are made with after-tax dollars, so there's no immediate tax break, but contributions and any potential earnings can grow tax-free. When qualified withdrawals are taken, there will be no taxes. Generally, a Roth IRA makes sense for those who will be in a higher tax bracket in retirement than they are today. 

Paying taxes up front can make a Roth IRA an attractive option for young savers whose only income comes from a summer job or part-time work, as they will almost certainly be in a higher tax bracket when they retire. Keep in mind, too, that the standard deduction for single filers for the 2024 tax year is $14,600. If your teen makes less than the standard deduction amount, they may not owe any federal taxes at all.

To open a Roth IRA for a minor, you'll need their tax identification number, which is usually their Social Security number. (Keep your own information, including your Social Security number, handy just in case you need it.) Once the account is open, you'll need to manage the account as their custodian, which includes selecting investments once the account is funded. Then, when your child reaches the "termination age," which is typically 18 or 21 (though, it's up to 25 in some states), your child takes over control of the account.

If the likelihood of a potentially smaller tax burden is one reason to consider a Roth IRA, then the sheer amount of time available to young investors willing to save for retirement is another. In fact, the earlier they start saving and investing, the less they'll likely have to set aside for retirement when they're older—thanks to the potential for compound growth.

The idea is that investments have the potential to generate income and appreciate in value over time. Those gains can be reinvested tax-free in an IRA, potentially leading to more income and growth, which can slowly accumulate year after year.

Here's a basic example of how compound growth can work in conjunction with a simple saving plan.

• Sara takes on summer gigs including dog walking and babysitting, and decides to contribute $2,300 of her earned income to a Roth IRA. To be sure, $2,300 can feel like a lot to a kid who's just getting started, but the burden will lighten significantly as she proceeds through her career. (Plus, she may not have to commit the full amount at the beginning, as we'll see below.) She keeps this up until age 65. Over 50 years she will end up contributing a total of $115,000 to her Roth IRA. Assuming she earns an average annual return of 6% over those 50 years, she would accumulate more than $$707,000.
• Chris doesn't start saving until he's settled in his career at age 30. Assuming the same 6% growth rate over the next 35 years (when he reaches age 65), Chris would have to set aside about $6,000 a year for a total of $$210,000 of contributions to equal Sara's ending account value. In the end, Chris had to save $95,000 more to end up with the same amount.

Of course, teenagers may be reluctant to give up too large a portion of their summer earnings for a retirement that could be many decades in the future. In that case, a parent could offer to match the dollar amount of any contributions or even gift their young worker some funds. However, the combined annual contributions can't exceed either the child's earned income or the annual contribution limit ($7,000 in 2024), whichever is lower. For example, if your kid makes $3,000 as a lifeguard over the summer and doesn't make any other money during the year, they could contribute just $3,000 to their account. 

What is earned income? For the purposes of a traditional or Roth IRA contributions, earned income includes any money that is earned for worked performed by the child. This could be from self-employment, like mowing lawns and babysitting, or income reported to them on a W-2. This could even include work doing small tasks for your family business, if you pay them a fair market wage. But remember, all this income must be reported to the IRS.

It won't. The good news is that retirement accounts aren't reported on the Free Application for Federal Student Aid (FAFSA). However, if a distribution is taken from a child's Roth IRA—say, to buy a car or help pay for tuition—the value will have to be reported as income on a future FAFSA form, which could affect financial aid eligibility. 

Encouraging your young worker to start investing early can also be a valuable lesson in financial responsibility and it could also potentially lighten the need to save in the future. Watching the account over time and engaging in discussions about it can help your child remain excited about personal finance and retirement planning. Kids who catch the "investing bug" at an early age may be more likely to continue contributing once they're managing their retirement nest eggs on their own. Before taking action, we recommend talking with a wealth advisor to see if Roth contributions make sense for you child.