Best retirement accounts for kids
Short answer
The best retirement accounts for kids are typically custodial Roth IRAs, which parents or guardians open and manage until the child is old enough. These accounts let kids start saving early with tax-free growth on money earned from jobs, helping build a strong financial foundation for their future retirement.
What is a retirement account for kids?
A retirement account for kids is a special kind of savings account designed to help children begin building money for retirement at a young age. Because kids usually aren’t earning a full adult salary, these accounts often require that the child has earned income from a job. Parents or guardians usually open a custodial account, where they manage the money for the child until they reach adulthood. The most common type is a custodial Roth IRA, which is a retirement savings account with tax advantages.
These accounts are different from regular savings accounts because the money grows tax-free or tax-deferred, and there are penalties for withdrawing money early, encouraging long-term savings. Starting a retirement account for a child takes advantage of the power of compound interest—small amounts saved early can grow significantly over decades. This early start can ease the child’s financial burden as they approach retirement.
How does a custodial Roth IRA for kids work?
A custodial Roth IRA allows a child to contribute money they’ve earned through work into a retirement account. Since kids usually don’t have a lot of earned income, their contributions are limited to what they make in wages, babysitting, lawn care, or other jobs. For example, if a child earns $1,000 from a summer job, they can contribute up to $1,000 to their Roth IRA that year.
Parents or guardians open the account in the child’s name and manage it until the child reaches the age of majority (usually 18 or 21, depending on the state). The money in the account is invested, often in stocks or bonds, and grows tax-free. When the child becomes an adult, they take over control of the account.
For example, if a kid deposits $1,000 at age 12 and makes no additional contributions, assuming an average 7% annual return, that money could grow to about $14,000 by age 65. If the child contributes $1,000 every year until age 18, the account could grow much more, setting a strong foundation for retirement savings.
Why does starting retirement savings early matter for kids?
Starting retirement savings early leverages the power of compounding, where earnings generate their own earnings over time. For kids, even small yearly contributions can turn into a substantial nest egg by the time they retire. Early saving also teaches valuable money skills like budgeting, investing, and financial responsibility.
For parents, opening a retirement account for their child can reduce future financial stress and provide a head start on building wealth that the child controls. It also helps children understand the value of saving for long-term goals rather than immediate spending.
Additionally, Roth IRAs have benefits like tax-free growth and tax-free withdrawals in retirement, making them a smart choice for kids who likely have many years before they need to access the money.
What other accounts or plans do people confuse with kids’ retirement accounts?
People often mix up retirement accounts with education savings accounts or general savings accounts. For example:
- 529 College Savings Plans: These are tax-advantaged accounts for education expenses, not retirement. They have different rules about withdrawals and taxes.
- Custodial Accounts (UGMA/UTMA): These accounts hold money for minors but do not have retirement-specific tax advantages.
- Regular Savings Accounts: These have no tax advantages and usually earn very low interest.
- 401(k) Plans: These employer-sponsored plans are generally not available to children unless they have a formal job with retirement benefits, which is rare.
Understanding these distinctions helps parents pick the right tool for their child’s financial future.
What are the eligibility requirements for kids’ retirement accounts?
To contribute to a retirement account like a Roth IRA, the child must have earned income. This means income from work such as a part-time job, babysitting, or freelancing. Income from gifts or allowances does not count.
The maximum contribution is the lesser of the child’s earned income or the annual IRA contribution limit set by the IRS. Parents cannot contribute more than the child earns.
Also, the account must be custodial if the child is under the age of majority. The custodian controls the account until the child is legally an adult. After that, the child gains full control.
What steps should parents take to open and manage a retirement account for their child?
Parents interested in starting a retirement account for their child should follow these steps:
- Confirm the child has earned income: Verify the child’s income from employment or self-employment.
- Choose the right account type: A custodial Roth IRA is often best for kids with earned income.
- Compare providers: Look for low fees, investment options, and educational resources.
- Open the account: Parents or guardians open the IRA in the child’s name as custodian.
- Make contributions: Deposit earned income up to the legal limit annually.
- Teach investment basics: Help the child select investments or use low-cost index funds.
- Monitor and educate: Review the account regularly, teaching the child about investing and long-term saving.
Starting early and maintaining consistent contributions helps build a strong retirement foundation. For more detailed steps on retirement savings basics for kids, see Retirement savings basics for kids.
What if the child doesn’t have earned income or wants to save for education?
If the child doesn’t have earned income or the goal is saving for college, a Roth IRA might not be suitable. Instead, parents can consider:
- 529 College Savings Plan: Designed specifically for education expenses, with tax advantages on withdrawals used for qualified costs.
- Custodial accounts (UGMA/UTMA): These allow parents to gift money to children without restrictions on use.
While Roth IRAs are excellent for retirement, it’s important to balance education savings needs. Parents can explore options to decide which account fits their family's goals best, such as comparing Roth IRA vs 529 college savings plans here.
Frequently asked questions
Can kids open a retirement account without earned income?
No, kids must have earned income from a job to contribute to a Roth IRA or similar retirement accounts. Gifts, allowances, or investment income do not qualify as earned income.
What happens to a custodial Roth IRA when the child turns 18?
The child gains full control of the account and can manage or withdraw funds subject to IRS rules. The custodian’s role ends at the age of majority.
How much can kids contribute annually to a Roth IRA?
Kids can contribute up to the amount of their earned income for the year or the IRS annual contribution limit for IRAs, whichever is less.
Are there penalties if kids withdraw money early from a Roth IRA?
Generally, withdrawing earnings before age 59½ may incur taxes and penalties, but contributions can be withdrawn anytime tax- and penalty-free.
Can parents contribute to their child’s Roth IRA?
Parents can contribute on behalf of the child, but total contributions cannot exceed the child’s earned income for the year.
What is the difference between a custodial Roth IRA and a UTMA account?
A custodial Roth IRA is a retirement account with tax benefits requiring earned income, while a UTMA account is a general custodial investment account without retirement-specific tax advantages.