Roth IRAs - powerful planning tools through the generations

If the current income restrictions associated with Roth individual retirement accounts (IRAs) prevent you from using one for your own planning purposes, consider taking steps to help ensure that your children or other younger family members establish and fund a Roth IRA of their own. Roth IRAs may offer tax benefits for retirement — particularly for younger investors. Yet perhaps the more long-lasting benefit of the Roth IRA can be realized when it is used as a wealth transfer mechanism.

Roth IRAs for minors

One of the main contributors to successful retirement planning is time — the more of it you have, the better the potential result. For this reason alone, setting up a Roth IRA for a child could be a good long-term planning strategy. When investment compounding has upward of 50 years to run its course, even a relatively modest savings rate could make a significant difference.

There is no minimum age requirement for opening a Roth IRA, and many IRA providers will accept accounts for minors. In most cases, the only real issue is whether the child has taxable earned income. Fortunately, there is no requirement that the same "earned income" is the money that funds the IRA. If your child earned income from a summer or part-time job but then spent it, there is no restriction on using money provided by parents to establish and fund the IRA.

You can contribute up to $7,000 to a Roth IRA in 2024 as long as your child earned at least that much. However, contributions cannot exceed your child's earned income for the year. Contributions to a Roth IRA are not tax deductible, but earnings are never taxed provided your child meets the distribution requirements — chief among them is the general requirement that he or she wait until at least 59½ before tapping the account.¹ While he or she probably cannot imagine ever being that old, there are other ways to put Roth IRA savings to good use prior to age 59½, such as the purchase of a first home.

Wealth transfer with a Roth IRA

As effective a retirement planning tool as a Roth IRA can be, its greatest strength may be its potential as a wealth transfer instrument. Unlike traditional IRAs, minimum distributions are not required from Roth IRAs once the owner reaches age 73, although distributions are due upon death. Therefore, a child theoretically could have held a Roth IRA for his or her entire life never having tapped into it and then pass it on to his or her beneficiaries upon death. At this point, the account would fall under the same minimum withdrawal rules that pertain to traditional IRAs. However, beneficiaries may be able to string out those withdrawals over many years, potentially continuing to earn tax-free income on the remaining account balance.

The hidden value of the Roth IRA is its tax-free growth potential. If heirs decide to spend or withdraw Roth IRA assets immediately upon inheritance, the Roth's strategic value as a wealth transfer tool is lost. If, however, they choose to withdraw only what is required by law each year, then the true power of the Roth IRA may potentially be realized.