Why a Roth IRA Is the Best Investment Account for Kids | Mora

If you’re looking to give your child a financial head start, a Custodial Roth IRA is hands down the most powerful savings account for kids in America.

Why? Tax-free growth, unmatched flexibility, and the power of compound interest working over time - all set your child up for lifelong financial security.

This article will cover:

• What Makes a Roth IRA So Powerful for Kids
• Why a Roth IRA is the Best Account for Kids
• How a Custodial Roth IRA Compares to Other Savings Accounts
• Simple Eligibility and Contribution Requirements
• Qualified Withdrawal Rules and Exceptions
• Easy Setup Guide

What Makes a Roth IRA So Powerful for Kids

A Roth IRA is a tax-advantaged account that allows contributions to grow completely tax-free. Unlike traditional IRAs, which provide an upfront tax break, Roth IRAs are funded with after-tax dollars. This means you don’t get a deduction now, but when it’s time to withdraw, both contributions and earnings come out tax-free.

For kids, this setup is especially powerful. Since they’re in the lowest tax bracket they’ll likely ever be in, paying taxes now means they can let their investment grow untouched by taxes for decades - making it a perfect way to build wealth over time.

Why a Roth IRA Is the Best Investment Account for Kids and Their Future

A Custodial Roth IRA is unbeatable for kids because it combines tax-free growth, flexibility, and long-term compounding - setting your child up for a secure financial future. Here’s why a Custodial Roth IRA outperforms other kids’ savings accounts:

1. Tax-Free Growth and Withdrawals in Retirement

A Roth IRA grows tax-free, and both earnings and withdrawals are completely tax-free if held until retirement age (post age 59.5). Unlike Custodial Brokerage Accounts or High-Yield Savings Accounts, which are taxed on earnings, a Roth IRA allows for uninterrupted, tax-free growth over time.

2. Flexible, Penalty-Free Withdrawals

One of the most versatile features of a Custodial Roth IRA is its flexibility in accessing funds. Contributions in a Roth IRA can be accessed anytime, tax-free and penalty-free - ideal for unexpected needs or big life milestones.

After 5 years, certain situations also allow for penalty-free withdrawals of earnings. While taxes may still apply, the following conditions allow you to avoid the 10% early withdrawal penalty:

Education Expenses

Your child can withdraw contributions at any time, tax- and penalty-free, to cover qualified education expenses. After five years, even earnings can be tapped for college or training costs without a penalty. This means access to funds for school without adding to student debt - an advantage that can set them up for success early on.

First-Time Home Purchase

The Roth IRA allows a tax- and penalty-free withdrawal of up to $10,000 in earnings for a first-time home purchase. When your child is ready to buy a home, they’ll have access to funds for a down payment, supporting financial independence while keeping long-term growth on track.

Health and Medical Expenses

In times of health or employment challenges, a Roth IRA allows penalty-free withdrawals for unreimbursed medical expenses or health insurance premiums during unemployment. This support protects their savings and helps them stay focused on health when it matters most.

Birth or Adoption Costs

For future family milestones, a Roth IRA allows penalty-free withdrawals up to $5,000 for birth or adoption expenses. This feature offers a valuable buffer during a major life transition, giving new parents quick access to funds while still preserving their nest egg.

3. Ideal for Long-Term Growth Through Compounding

A Roth IRA capitalizes on the power of compound interest over a long timeline. By investing early, a child’s Roth IRA contributions have decades to grow, creating significant wealth by the time they reach retirement.

For instance, starting a Custodial Roth IRA at age 3 with $6,995 added annually at a 7% return could grow to around $7.9 million by age 59. Delaying until age 15 reduces this to $2.9 million - a loss of $5 million due to the delayed start.

Other accounts, like 529 Plans or Custodial Brokerage Accounts, offer less advantage in terms of tax-free compounding or come with limitations on spending.

‍Use Mora’s Wealth Calculator to visualize the long-term benefits of starting early.

4. No Required Minimum Distributions (RMDs)

Unlike a Custodial Traditional IRA, which requires withdrawals starting at age 73, a Roth IRA has no RMDs, allowing funds to grow tax-free indefinitely. This means your child’s savings can continue building wealth, free from mandatory withdrawals.

5. Control and Legacy Planning

While a Custodial Roth IRA is managed by a parent until the child reaches adulthood, ownership ultimately transfers fully to the child, giving them control. 

Here is how it works:

• You Are the Custodian: As the parent or guardian, you control the account and make all investment decisions while your child is a minor. This allows you to guide the investment strategy and maximize growth based on your financial knowledge.
• Transfer of Control at Adulthood: When your child reaches the age of majority (usually 18 or 21, depending on your state), the account transitions to their control. They gain full ownership and can make their own investment decisions and withdrawals as they see fit, ending your role as custodian.

This setup builds financial responsibility and provides an account designed for both immediate needs and long-term security.

6. Better Than a Traditional IRA for Kids’ Low Tax Bracket

Unlike a Traditional IRA, which offers tax-deferred growth and tax withdrawals, a Roth IRA is perfectly suited for children, who are typically in a low (or even zero) tax bracket. 

They pay taxes upfront at a low rate, then enjoy tax-free growth and withdrawals, especially beneficial as they move into higher tax brackets as adults.

Why a Roth IRA Is the Best Investment Account for Kids Compared To Other Accounts

When compared side-by-side, a Roth IRA’s combination of tax-free growth, flexible withdrawals, and lack of RMDs makes it superior to Custodial Brokerage Accounts, 529 Plans, High-Yield Savings Accounts, and even Traditional IRAs for building a child’s financial future.

While other accounts have niche uses, only the Roth IRA truly excels at providing both a retirement foundation and flexible access for life events.

Eligibility and Contribution Requirements

To take advantage of a Custodial Roth IRA, your child needs to meet specific eligibility and contribution requirements.

• Earned Income Requirement: The key requirement for contributing to a Custodial Roth IRA is that your child must have earned income - that means income subject to tax. This can come from a part-time job, freelance work, or even self-employment jobs like babysitting or lawn care. Importantly, allowances or gifts do not qualify as earned income.

Deborah Horwith, Registered Chartered Professional Accountant, breaks down what can be considered income for your child.

• Annual Contribution Limit: The IRS sets contribution limits for Custodial Roth IRAs, adjusting them each year, often in line with inflation. For 2024 and 2025, the maximum contribution is set at $7,000 for individuals under 50. 
• Contributions Made with After-Tax Dollars: Contributions to a Roth IRA are made with after-tax dollars, meaning no tax deduction is available upfront. This sets your child up for tax-free growth and withdrawals in the future, especially advantageous given their low income tax rate today.

How To Set up a Custodial Roth IRA

Setting up a Custodial Roth IRA is a straightforward process and only requires a few essential steps to get your child on the path to tax-free growth. Here’s a brief overview:

• Ensure Your Child is Eligible: The IRS requires that the child has earned income to contribute to a Roth IRA.
• Choose a Trusted Financial Provider: Research financial institutions offering low fees and diverse investment options like Fidelity or Charles Schwab.
• Gather Required Documentation: To meet IRS requirements, establish documentation that proves a legitimate working relationship (see the full list in our in-depth guide).
• Set Up Contributions: Once the account is live, it’s time to fund it.

For a more in-depth comprehensive guide check out our article ‘Setting Up a Roth IRA for Your Kids: A Step-by-Step Guide’.

How Mora Simplifies Setting Up a Roth IRA for Kids

Planning for your child’s financial success doesn’t have to be complicated.

At Mora, we provide hands-on support for setting up a Custodial Roth IRA, offering guidance on documents, compliance, and long-term investment strategies.

Our goal? To make the process seamless, so you can give your child a powerful head start toward tax-free retirement savings.

Custodial Roth IRA Savings Account FAQs

• Why is a Custodial Roth IRA better than other kids’ savings accounts?
  A Custodial Roth IRA stands out for its tax-free growth, flexibility, and long-term compounding. Unlike traditional savings or college plans, it offers unmatched tax benefits and compounding power over time.
• Does my child need to file a tax return to contribute?
  No, as long as their total income is below the IRS threshold. Just keep proof of all required documents in case the IRS requests verification.
• What are the tax benefits?
  Contributions are made with after-tax dollars, so there’s no upfront deduction, but all growth and retirement withdrawals are tax-free- a huge advantage for kids with decades to let their investments grow.
• When can my child access the funds?
  Contributions can be withdrawn anytime, tax- and penalty-free. Earnings are accessible tax-free after age 59½ or for qualified expenses like first-time home purchase (up to $10,000) and education.
• Does it become a regular Roth IRA when my child reaches adulthood?
  Yes, upon reaching the age of majority (18 or 21), the account converts to a regular Roth IRA, and they gain full control to manage and contribute independently.

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