T. Rowe Price Personal Investor - How a Custodial IRA Can Help Your Child With Future Retirement Savings (2024)

FAQs

What are the benefits of a custodial IRA? ›

All funds in the account belong to the child, allowing them to start saving money early. In addition to reaping the benefits of compounded growth, your child may be able to use the funds for future expenses like college tuition or even to buy a first home.

A Custodial Roth IRA presents a unique opportunity to foster early financial growth and education for minors. However, it's crucial to weigh these advantages against potential drawbacks, including loss of control, contribution limits, financial aid implications, and tax penalties.

What is the maximum custodial Roth IRA contribution? The maximum amount you can contribute to a custodial Roth IRA is $7,000 for 2024. So even if your child earns $10,000 during the year, they can fund the Roth IRA at the max of $7,000.

If you manage a custodial IRA for your child, they will assume complete control over the account when they turn 18 (or 21 in some states). This means they are free to continue contributing, or they can liquidate the account to pay for their first home, college tuition, or any other expense.

The tax treatment is the same as a regular Roth IRA since you make contributions with after-tax money. Withdrawals are also tax-free as long as they meet the qualified distribution criteria, which typically means that the account has been open for at least five years and the account owner has reached age 59 ½.

Custodial accounts come with specific benefits and drawbacks. The main advantage is the account's flexibility. Another benefit is that custodial accounts are relatively inexpensive compared to trusts. The chief disadvantage is that custodians lose control of the money once the minor reaches the age of majority.

In general, the Roth IRA is the IRA of choice for minors who have limited income now. By the same logic, it's often recommended for adults who expect to be in a higher tax bracket in the future. "If a child keeps [a Roth] until age 59½ (under today's rules), any withdrawal will be tax-free.

Unlike 529 plans and ESAs, custodial accounts are subject to the so-called "kiddie tax." This tax rule applies to unearned income (i.e., investment income) up to a certain threshold. Over that threshold, the child will pay taxes at the parent's tax rate. To learn more, see IRS Publication 929.

Withdrawals: Withdrawals from custodial accounts must be used for the benefit of the minor. Once the minor reaches the age of majority, they can use the money for any purpose without any restrictions. 5. Contribution limits: Custodial accounts have contribution limits, which vary depending on the type of account.

After withdrawing the funds, if you decide to gift them to your children, consider the following: Annual Gift Tax Exclusion: For 2023, you can gift up to $16,000 per recipient without incurring any gift tax or needing to report the gift. This amount is periodically adjusted for inflation.

Can I open a custodial IRA for my child? ›

But here's the catch: custodial Roth IRA eligibility is based on your child's income, not yours. That's right — for you to open and contribute to a custodial Roth IRA on behalf of your child, your child must have earned income of their own, either from a job or another source.

Impact on Financial Aid: While contributions to a Custodial Roth IRA do not impact federal financial aid calculations, withdrawals may. This could affect a child's eligibility for certain financial aid programs.

A custodial Roth IRA works much the same way except the parent has to open the account. The parent is then designated as the custodian of the account and the minor child is designated as the beneficiary.

However, until the child is 18, the account will require a named custodian -- typically a parent -- to monitor the account and invest the money. Once the child turns 18 (or 21 in some states), the account will be transferred to his or her name in its entirety, and it will function like a regular Roth IRA.

A portion (up to $1,250 in 2024) of any earnings from a custodial account may be exempt from federal income tax, and a portion (up to $1,250 in 2024) of any earnings in excess of the exempt amount may be taxed at the child's tax rate, which is generally lower than the parent's tax rate.

For the most part, a custodial Roth IRA operates in the same way as a regular Roth IRA. There is one main difference between these two types of accounts: Because custodial Roth IRAs involve minors, they need to have a parent (or another adult) assigned as a custodian.

Gathers, executes, and holds documents such as subscription agreements, operating agreements, offering memorandum, promissory notes, certificates, and other evidences of ownership of investments by the IRA. Receives and records income from the assets held in the IRA.

Custodial accounts may not offer the tax benefits of 529 plans, but they can be used to fund expenses that 529 plans don't cover. If you want to set aside money for college expenses that aren't covered by an Education Savings Account (ESA) or 529 plan, a custodial account might help.