Finance
How Much Should You Put Into Your Child’s Roth IRA? | Mora
November 20, 2024
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Giving your child a head start on financial independence starts with understanding how much to contribute to their Roth IRA. Contributions must align with IRS rules, including annual limits and earned income requirements, to avoid penalties and ensure long-term growth.
In this guide, we’ll walk you through:
- Roth IRA contribution rules for children
- How to determine the right contribution amount
- Avoiding penalties for excess contributions
- Strategies for maximizing your child’s Roth IRA
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Why Choose a Roth IRA for Kids?
A Roth IRA offers unparalleled flexibility and tax-free growth, making it a standout option for securing your child’s financial future. Here’s why it’s the ultimate choice:
- Tax-Free Growth: Gains grow entirely tax-free, ensuring your child keeps 100% of their hard-earned money.
- Compound Interest: Starting early lets small contributions grow exponentially over decades.
- Penalty-Free Access for Key Life Events: From education to buying a first home, funds can be accessed penalty-free for qualified expenses.
- No Required Minimum Distributions (RMDs): Unlike traditional accounts, Roth IRAs allow savings to grow indefinitely.
Understanding Roth IRA Contribution Limits for Kids
To make the most of your child’s Roth IRA, it’s essential to understand how contribution limits work. Contribution amounts depend on IRS-defined annual limits and your child’s earned income. Following these rules ensures compliance while maximizing tax-free growth potential.
Annual Contribution Limits
For 2024 and 2025, the maximum contribution limit for Roth IRAs is $7,000 for individuals under 50 and $8,000 for those aged 50 and older (including a $1,000 catch-up contribution). However, a child’s contributions cannot exceed their earned income for the year.
Example: If your child earns $3,000 babysitting or doing part-time work, their maximum contribution for that tax year is $3,000 - even if the annual limit is $7,000.
Who Can Contribute to Your Child’s Roth IRA?
One of the unique aspects of a Custodial Roth IRA is the flexibility in funding it. While contributions must not exceed your child’s earned income, the actual source of the funds can come from you as the parent.
Example: If Megan earns $2,000 through babysitting, that amount is the maximum she’s allowed to contribute for the year. However, the $2,000 doesn’t have to come directly from her pocket. Megan can use their earnings for spending, saving, or other needs, and Megan’s parents can contribute $2,000 of their own money into their Roth IRA instead. By investing $2,000 annually from age 12 to 59½ at a 7% return, Megan could grow her Roth IRA to over $670,000, completely tax-free.
This flexibility ensures that your child can enjoy the benefits of their earnings while still building long-term tax-free savings. It’s a win-win: your child learns the value of earning and spending wisely, and their Roth IRA sets them up for financial independence.
How Much Should You Contribute?
Deciding how much to contribute isn’t just a financial decision; it’s a chance to shape your child’s financial future. Even small, consistent contributions can transform into a significant nest egg, unlocking lifelong security.
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Start Early and Stay Consistent
When it comes to Roth IRAs, the earlier you start contributing, the greater the potential for long-term growth. The power of compound interest means even small, consistent contributions can transform into life-changing wealth over time. However, both the amount you contribute and the time you start investing play crucial roles. Let’s break it down.
How Different Contribution Amounts Impact Growth
Every dollar you contribute to your child’s Roth IRA has the potential to grow exponentially. Even modest amounts invested weekly or monthly can lead to significant rewards over time.
Example: Here’s how varying contribution amounts can impact growth when starting at age 5, with a 7% annual return
$20 per week: ~$18,000 by age 18 / ~$440,000 by age 59½
$50 per week: ~$45,000 by age 18 / ~$1,100,000 by age 59½
$100 per week: ~$90,000 by age 18 / ~$2,200,000 by age 59½
Even small contributions, like $20 a week, can grow into hundreds of thousands of dollars. Increasing your weekly contribution accelerates these results, making it possible to reach millionaire status by retirement.
How Different Start Ages Impact Growth
The earlier you begin contributing to a Roth IRA, the longer your child’s savings have to compound tax-free. Even with the same annual contributions, starting at a younger age creates dramatically different results due to the power of time.
Example: Here’s how starting age can impact growth when contributing $20 a day, with a 7% annual return:
Start at age 3: ~$7.9 million by age 59½
Start at age 15: ~$2.9 million by age 59½
Start at age 25: ~$1.4 million by age 59½
Time is the ultimate multiplier for wealth. A 12-year delay in starting contributions (from age 3 to 15) could mean losing out on over $5 million in potential growth by age 59½. Starting early gives your child a powerful head start, creating financial freedom and opportunities for life.
Use Mora’s Wealth Calculator to see how starting early can turn small steps into monumental growth.
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Prioritize Tax-Free Growth Potential
Contributions are made with after-tax dollars, ensuring that all gains and qualified withdrawals remain entirely tax-free.
To make the most of this benefit, prioritize funding the account up to your child’s earned income limit. This approach ensures you’re maximizing their long-term growth potential while staying compliant with IRS rules.
Avoiding Excess Contributions and Penalties
Roth IRA contributions are governed by strict IRS rules, and exceeding the annual limit or your child’s earned income can trigger penalties. While these rules might feel complex, staying informed ensures your child’s Roth IRA remains a powerful tool for building wealth.
What Happens When You Over-Contribute
Contributing more than your child’s earned income - or exceeding the annual contribution limit-results in a 6% IRS penalty on the excess amount every year until it’s corrected.
Example: Tim earns $4,000 but contributes $5,000, the $1,000 excess incurs a $60 penalty annually (6% of $1,000). If not corrected for three years, the total penalty adds up to $180, reducing the account’s growth potential.
How to Correct Excess Contributions
Mistakes happen, but correcting an over-contribution is straightforward. To avoid ongoing penalties, withdraw the excess amount and any earnings associated with it before the tax filing deadline. This ensures compliance and keeps your child’s Roth IRA on track for long-term growth.
With Mora’s expert guidance, managing contributions and keeping your child’s Roth IRA penalty-free is easier than ever.
Maximizing Contributions: Strategies to Build Wealth
Maximizing your child’s Roth IRA contributions isn’t just about hitting limits-it’s about building habits and adopting strategies that take full advantage of this powerful savings tool.
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Leverage Early Earnings
Encourage your child to contribute part of their earnings from part-time jobs or self-employment directly into their Roth IRA. This teaches financial responsibility while taking advantage of compound growth.
Aligning Education and Retirement Savings for Maximum Flexibility
Roth IRAs are uniquely flexible, allowing your child to excess contributions - penalty-free - for key milestones like higher education or entrepreneurial ventures.
Contributions, made with after-tax dollars, can be withdrawn anytime to support these opportunities without impacting the account's tax-advantaged growth.
However, leaving as much in the account as possible maximizes its long-term potential, ensuring both short-term goals and lifelong financial security are met.
Example: Sophie’s parents started contributing $50 a week to her Roth IRA when she was 10 years old. By the time Sophie turned 22, her Roth IRA had grown to $38,000. At age 22, Sophie withdrew $10,000 to fund the down payment on her first home. Here’s what happened next:
Account Before Withdrawal: $38,000
Withdrawal Amount: $10,000 (penalty-free as contributions were used)
Remaining Account Balance: $28,000
Despite this withdrawal, Sophie continued to contribute $50 a week, allowing her account to grow. By age 59½, her account balance had grown to $250,000, demonstrating the incredible power of compounding - even with a withdrawal.
What If Sophie Hadn’t Withdrawn?
Had Sophie left the $10,000 untouched in her Roth IRA, her account would have grown to $310,000 by age 59½ - a difference of $60,000. However, the $10,000 she used for her home helped her secure a safe and stable living environment, setting her up for long-term success.
Key Advantages for Sophie:
1. Flexibility for Life Goals: Sophie was able to achieve a major life milestone (homeownership) without financial strain.
2. Preservation of Growth: Even with the withdrawal, her remaining contributions continued to grow tax-free, providing her with a robust retirement fund.
3. Financial Balance: The penalty-free withdrawal allowed Sophie to meet immediate needs without sacrificing long-term security.
Mistakes to Avoid When Creating Tax-Free Retirement Savings for Kids
Even with the best intentions, common mistakes can reduce the effectiveness of a Roth IRA. Here’s what to watch out for:
Skipping Documentation: Always maintain clear records of your child’s earned income to comply with IRS rules.
Over-Contributing: Contributions can’t exceed your child’s earned income or the annual IRS limit - exceeding either results in penalties.
Overlooking Custodial Responsibilities: As the custodian, you must manage the account in your child’s best interest until they reach adulthood.
Explore our guide, ‘6 Mistakes to Avoid When Setting Up Your Child’s Roth IRA,’ for more details.
How Mora Simplifies Setting Up a Roth IRA for Kids
At Mora, we’re here to make the process seamless. Let us handle the details, so you can focus on giving your child the best possible financial future.
With Mora’s expert guidance, setting up and managing your child’s Roth IRA becomes effortless. We’ll ensure compliance, help organize documents, and maximize contributions for long-term tax-free growth.
Book a free 1:1 call with Mora's Founder Murti.
FAQs About Tax-Free Retirement Savings for Kids
- Q: How much should I contribute to my child’s Roth IRA?
Contributions should match your child’s earned income, up to the annual limit. For 2024, this is $7,000 for individuals under 50. - Q: Can I contribute to my child’s Roth IRA if they don’t have earned income?
No. Contributions must come from taxable earned income, such as wages or self-employment income. - Q: Are withdrawals from a Roth IRA really tax-free?
Yes, contributions are always tax-free to withdraw. Earnings are tax-free after age 59½ or for qualified expenses like education or a first-time home purchase. - Q: What happens if my child stops earning income?
Contributions can only be made for years in which the child has earned income. However, existing funds in the account will continue to grow tax-free.
Ready to get started? Let Mora’s experts simplify the process. Book a free 1:1 call with Murti today!
Your Kids Could Lose Almost $400k Every Year you Wait
A Mora Kids Roth IRA is designed to maximize the power of compounding by starting early.
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