Setting Up a Roth IRA for Your Kids: A Step-by-Step Guide

A Custodial Roth IRA is the most powerful savings account for kids in America, offering tax-free growth that compounds over decades. With just a small upfront investment and time, you can create a powerful financial tool that grows with them and provides a foundation for retirement and other significant life events.

In this article, we will look at:

• Why Choose a Roth IRA for Your Kids & their Key Benefits?
• How Does a Custodial Roth IRA Work?
• Contribution Rules and Tax Implications
• Step-by-Step Guide to Setting Up a Custodial Roth IRA

Why Choose a Roth IRA for Your Kids?

A Custodial Roth IRA is the ultimate retirement account for your child. Unlike regular investment accounts, a Roth IRA ensures both growth and future withdrawals are completely tax-free - making it one of the best tools available to build generational wealth for your kids.

Key Benefits of a Roth IRA for Kids

• Tax-Free Growth: Roth IRAs let your child’s investments grow completely tax-free. Unlike a standard brokerage account, which can lose up to 50% of gains to taxes, every dollar in a Roth IRA stays untouched, building wealth faster and smarter.
• Compound Interest: Starting early means maximizing the power of compounding—where your money earns money, and then that money earns more. It’s why Albert Einstein dubbed compounding the “eighth wonder of the world.” Even small contributions today can turn into life-changing savings by retirement.
• No Required Minimum Distributions (RMDs): Unlike traditional retirement accounts, Roth IRAs allow your child’s savings to grow indefinitely without mandatory withdrawals. This flexibility ensures their wealth can keep building until they’re ready to use it.

Qualified Withdrawals for a Custodial Roth IRA

Roth IRAs offer unique flexibility, making them a powerful option for your child’s future. Here’s what you need to know:

• Contributions: You can withdraw contributions anytime, tax- and penalty-free since they’re made with after-tax dollars.
• Qualified Withdrawals (Earnings): After 5 years, earnings can also be withdrawn tax- and penalty-free if one of the following conditions is met:
  • The account holder is 59½ or older.
  • The withdrawal is used for a first-time home purchase (up to a $10,000 lifetime limit).
  • The account holder becomes disabled.
  • The withdrawal is made to beneficiaries after the account holder’s death.
• Early Withdrawals of Earnings: If you withdraw earnings before the account is 5 years old or without meeting the conditions above, there may be a 10% penalty on the earnings portion only, and earnings may also be subject to income taxes.
• Penalty-Free Exceptions for Early Withdrawals: Certain situations allow for penalty-free withdrawals of earnings, even if the 5-year rule isn’t satisfied. While taxes may still apply, the following conditions allow you to avoid the 10% early withdrawal penalty:
  • Education expenses: Qualified higher education expenses for yourself, your spouse, children, or grandchildren.
  • Medical expenses: Unreimbursed medical expenses exceeding 7.5% of your adjusted gross income.
  • Health insurance premiums: If you are unemployed and meet specific conditions.
  • Birth or adoption expenses: Up to $5,000 within one year of birth or adoption.
  • IRS levy: If the IRS places a levy on your Roth IRA.
• Order of Withdrawals: Withdrawals from a Roth IRA follow a specific order to maximize tax efficiency:
  • Contributions: Always withdrawn first, completely tax- and penalty-free.
  • Conversions: Withdrawn second; if withdrawn before 5 years, conversions may incur a penalty (though not taxes).
  • Earnings: Withdrawn last, subject to taxes and penalties unless qualified.

How Does a Custodial Roth IRA Work?

A Custodial Roth IRA lets you manage a powerful investment account for your child until they reach adulthood. Here’s how it operates:

• 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.

Is Your Child Eligible for a Custodial Roth IRA? 

To qualify for a Custodial Roth IRA, your child can be any age but must have earned income—that means income subject to tax, not just money given as a gift or allowance. Here’s what qualifies:

• Earned Income: This includes any taxable wages from part-time work or self-employment. For traditional jobs, wages are typically reported on a W-2 form, while income from self-employment may be reported on a 1099 form.
• What Doesn’t Count: Passive income sources, like investment dividends, allowances, or gifts, don’t qualify as earned income for Roth IRA contributions.

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

Contribution Rules and Tax Implications

Custodial Roth IRAs are straightforward when it comes to contribution rules and tax-free growth. Here’s what you need to know to maximize this account 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. 
  • While specific future increases are not announced, it's reasonable to anticipate that the IRS will continue to adjust these limits periodically to account for inflation and other economic factors. Here’s a look at how contribution limits could increase based on historical data:

• Tax-Free Growth Advantage: Since contributions to a Roth IRA are made with after-tax dollars, all future growth is entirely tax-free. This means every dollar earned in this account compounds with zero tax implications, setting your child up for untouched growth over the years.
• No Immediate Tax Deduction: Unlike some accounts, Roth IRAs don’t offer a tax deduction at the time of contribution. But for minors in lower tax brackets, this isn’t a disadvantage. Instead, they get to lock in the long-term benefit of tax-free withdrawals in retirement.

Step-by-Step Guide to Setting Up a Custodial Roth IRA

Setting up a Custodial Roth IRA for your child doesn’t just build wealth—it creates a financial legacy. Here’s how to set an account up.

Step 1: Make Sure Your Child Has Earned Income 

Before starting, confirm your child has earned income from a job, self-employment, or other paid activity. (Quick reminder: allowances, gifts, or any unearned income don’t qualify). Once they have earned income, they’re eligible, and you’re ready to go.

Step 2: Choose a Trusted Financial Provider 

Several respected institutions offer Custodial Roth IRAs—like Fidelity or Charles Schwab, known for low fees and a straightforward online process.

Ready to set it up? Here’s a link to Fidelity’s setup page; you’ll be done in about five minutes.

Step 3: Gather the Required Documents 

To set up your child’s Custodial Roth IRA and meet the IRS requirements for earned income, you’ll need to establish documentation that proves a legitimate working relationship. Here’s what you’ll need:

• Job Description: A brief overview of the tasks and responsibilities performed by your child helps verify that it’s real work.
• W-2 or 1099 Form: If your child is an official employee, you’ll need to issue a W-2. If they're contracted, a 1099 form works. These forms show earned income, which qualifies them to contribute to a Roth IRA.
• ‍Time Sheets: Documented hours worked to show a regular schedule.‍
• Pay Stubs: Records of payments issued to your child.‍
• Employment Agreements: An agreement outlining duties, responsibilities, and pay.‍
• Compliance with Child Labor Laws: Ensure your child’s work aligns with federal child labor laws.‍
• State-Specific Requirements: Depending on your state, additional filings or compliance steps may be needed.

Anthony Kim, Tax Attorney & Partner at Kim & Rosado, breaksdown what documents are needed to show employer relationship.

Mora’s onboarding team will guide you in preparing and organizing these documents seamlessly, so you’re set up for compliance and tax savings.

Step 4: Fund the Account and Set Up Contributions 

Once the account is live, it’s time to fund it. Contributions can come from either you or your child, as long as they don’t exceed the child’s earned income for the year. 

Mora makes linking your bank account and setting up regular contributions simple, so you can focus on a growth-oriented investment strategy. 

How Mora Simplifies Setting Up a Roth IRA for Kids

At Mora, we’re passionate about helping parents secure their children’s financial future. 

With Mora’s personalized approach, you’ll benefit from streamlined setup, expert guidance on investments, and peace of mind knowing you’re giving your child a head start on lifelong financial security. 

We will guide you in preparing and organizing all documents needed seamlessly, so you’re set up for compliance and tax savings.

Setting Up a Roth IRA for Your Kids Frequently Asked Questions

• What is the best age to start a Roth IRA for my child? There’s no minimum age as long as the child has earned income. Starting early maximizes the benefits of compound interest. Need more guidance? Mora’s team is here to help you navigate each step.
• Can Roth IRA funds be used for college expenses? Yes, contributions can be withdrawn tax- and penalty-free for qualified education expenses. Mora can help you plan to take full advantage.
• How do I start a Roth IRA for my child? Choose a Custodial Roth IRA account, provide earned income documentation, and decide on a contribution strategy. If you have questions, our experts can simplify each stage.
• What happens to the Roth IRA when my child becomes an adult? Control of the account transfers to them once they reach the age of majority, allowing continued contributions and management. Reach out to our experts to discuss long-term strategies to maximize your child’s investment.

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