What Parents Should Know About Custodial Roth IRAs

When it comes to money, my kids are still mainly concerned with Tooth Fairy gifts and allowance payments. That doesn’t mean I can’t set my own sights a little more long- term. Getting a jump start on saving for my kids’ retirement can help them enter adulthood with more security.

If your kids are working, one way to prepare for their financial future is by opening a custodial Roth IRA. They may even be able to use the funds well before they reach retirement age. Here are the rules and details you should know about Roth IRA accounts for kids.

What Is a Roth IRA for Kids?

A Roth IRA for kids, or custodial Roth IRA, is an individual retirement account that an adult opens and manages on behalf of a minor (e.g., your child). By starting early, you may be able to get a meaningful head start on retirement funds for your child before they even leave home. There are also a few ways for your child to use some Roth IRA funds before retirement age without facing taxes or penalties.

You need earned income to open an IRA, so a custodial Roth IRA is only an option if your child has some form of employment. That said, there’s no minimum age limit.

Traditional vs. Roth IRA

With a traditional IRA, you contribute pre-tax money. Money in the account grows tax deferred, so you don’t pay income taxes on contributions or earnings until you start taking withdrawals.

Roth IRA contributions come from after-tax money (i.e., you pay taxes on the income the year it’s earned). Earnings grow tax free, and qualified withdrawals are tax and penalty free.

You can open either a Roth or traditional IRA for your child. Because many children are in a very low tax bracket, it can make good financial sense to choose a Roth IRA to pay applicable taxes now and get the advantage of tax-free withdrawals later. Which option is best for you depends on your child’s current tax bracket and what you expect to happen in the future.

Custodial Roth IRA Contribution Rules

The main requirement to open a Roth IRA for kids is that you’ll need to be able to demonstrate that your child earns income. This can be a significant hurdle, since only about 22% of high schoolers had a job as of October 2023, and the vast majority of young children don’t earn income.

What counts as earned income (and what doesn’t)?

Some cases are easy to judge—a part-time job as a lifeguard counts as earned income, whereas allowance and birthday card cash do not. But what about more gray-area earnings?

Cash-based gig jobs your child does (e.g., babysitting) can potentially count as earned income. Keep records of the job details (e.g., when your child worked, for whom, exactly how much they earned), and check with a financial professional about any other requirements you may need to meet. For example, the wages may need to align with a reasonable going rate—in other words, you likely can’t pay your child $800 to mow your lawn. But if your child rakes leaves for neighbors as well as your own yard, and earns a reasonable rate, that income may be more likely to be accepted as earned income, even without a formal paycheck.

Contribution limits

You can contribute the total amount of your child’s earned income or up to $7,000 as of 2025, whichever is less. This contribution maximum is a hard limit no matter how many people are contributing or how many IRA accounts you have. If you have a traditional IRA and a Roth IRA for your child, for example, the maximum limit of the lesser amount of $7,000 or 100% of their income applies to total contributions across both accounts.

Are Roth IRA earnings taxable?

Contributions grow tax free. Thanks to compounding, your contributions and earnings may have the potential to grow into a meaningful resource for your child to use in adulthood. If your child waits until age 591⁄2 to take distributions, the earnings will be tax free. If they take withdrawals earlier, they may need to pay income tax (and possibly an additional 10% tax penalty) on the earnings portion of the distribution.

Custodial Roth IRA Withdrawal Rules

Generally speaking, a custodial Roth IRA is a retirement account at its core. The default expectation is that your child won’t start taking regular distributions (i.e., withdrawals) until age 591⁄2. A UGMA account, on the other hand, is a custodial account your child can use freely without penalty as soon as they reach adulthood and take over the account. Read more on Roth IRAs vs. UGMA accounts.

Once a Roth IRA has been funded for at least five years and the account owner is 591⁄2, qualified withdrawals won’t have taxes or penalties (meaning gains aren’t taxed, either). Before then, your child may face more restrictions on withdrawing money from the account.

If you withdraw money early, you’ll generally have to pay an extra 10% tax in addition to any taxes you owe. Here are a few ways to withdraw money early from a Roth IRA without penalties:

• Withdraw original contributions only (not earnings): Contributions come from after-tax dollars, so no taxes are owed on these funds. You can withdraw contributions without penalty at any time.

• Pay for college: You can use Roth IRA funds to pay for qualified higher education expenses, like college tuition.

• Buy a home: First-time home buyers can withdraw up to $10,000 to buy a home.

• Have a baby: You can take up to $5,000 for a qualified birth or adoption

  withdrawal.

There are also some exceptions to the 10% additional tax penalty if you take a withdrawal because you’re permanently disabled, have a terminal illness or experience certain other extreme situations (e.g., federal disaster).

In any of these cases, you may still need to pay applicable income taxes on any part of the withdrawal you need to include in your gross income (e.g., earnings).

Will a Roth IRA Affect College Financial Aid?

Your choice of account type can make a big difference in college financial aid eligibility, in terms of how they view the student’s available assets to pay for tuition.

A custodial Roth IRA is a retirement account as far as the FAFSA is concerned, even if your child plans to take penalty-free distributions to use for college expenses. Funds in a Roth IRA or other retirement account won’t appear on the FAFSA, so they won’t count against financial aid eligibility for colleges that use the FAFSA. A small number of colleges and universities use the CSS Profile, which may ask for information about retirement accounts (although even then, colleges often won’t factor retirement assets against need-based aid).

How Does Custodial Roth IRA Transfer to the Child’s Control?

When your child reaches adulthood, they’ll take control of the account. Age varies by state, but custodial accounts usually transfer when the child reaches age 18 or 21. Typically, your child would need to open their own Roth IRA, and you’d transfer the assets from the custodial account to the new account in their name.

Alternatives to a Custodial Roth IRA

A custodial Roth IRA can be a good fit for some parents who want to start saving for their kids’ retirement early and prioritize tax-advantaged growth. But this is only an option if your child earns income, and even then, the maximum contribution may be lower than the amount you’d like to put toward your child’s future. Some alternative accounts you might try include:

• UGMA/UTMA account: These custodial accounts have some tax advantages (although not as many as a Roth IRA), and they don’t have contribution limits or restrictions on how your child uses the money once they take over the account.

• 529 plan: A 529 account is one way to save for college that can offer tax- deferred growth and tax-free withdrawals for qualified education expenses. You may have less flexibility over how your child can use the money in the account.

• Bank savings: A secure way to save money for your child, without restrictions on how or when you can use the money. You won’t get the advantage of potential investment growth, and interest rates often don’t keep up with inflation, so the growth potential is more limited.

Taking small steps to help grow money for your child’s future can add up, especially when you have a long time horizon for your contributions to grow. If your child earns money, starting a custodial Roth IRA can be a great option to consider as part of your preparations.

Fabric exists to help young families master their money. Our articles abide by strict editorial standards. This article has been reviewed and approved by a compliance professional who is a licensed life insurance agent.

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