Does it really make sense to start a retirement account for my child?


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How to Open a Retirement Account for Your Child

Opening a retirement fund for a child means opening a custodial IRA. Generally speaking, a custodial account is one that’s owned by an adult — a parent, grandparent, or legal guardian — on behalf of a minor.

The adult does the investment planning for their child, and manages the money in the account until the child reaches the age of majority (it varies by state). At that point, all the money in the account belongs to the child.

Steps to Opening a Retirement Account for a Child

Here’s how opening a retirement account for minors typically works.

Step 1: Choose a Brokerage

Custodial IRAs are offered by many brokerages, so you’ll need to choose where to open yours. This could be the brokerage where you currently have your investment accounts or a different one.

When deciding on a custodial IRA, consider the range of investments offered, the fees you’re likely to pay, and how easy it is overall to open and manage new accounts. For example, some brokerages let you set up an IRA for a child online, while others require you to fill out and mail in the necessary paperwork.

Step 2: Complete the Application

On the application for a custodial IRA, the brokerage will typically ask for specific information, including:

  • Contact information (e.g., your phone number, email address, and mailing address)
  • Personal information about yourself, including your name, date of birth, and Social Security number
  • Personal information about your minor child, including their name, date of birth, and Social Security number
  • Employment information, if applicable
  • You’ll also need to share routing information and the account number for the bank account you plan to use to make contributions. If you’re moving money from another brokerage firm, you’ll be asked to provide the account number and type.

Step 3: Choose an IRA Type

Should you choose a traditional or a Roth IRA for your child? Both offer tax benefits and both have the same annual contribution limits for kids. For minors, a Roth IRA typically works better. One reason is that the child’s tax rate is typically quite low, and likely much lower than their tax rate will be upon retirement.

Step 4: Fund the Account and Choose Investments

Once you’ve opened a retirement account for a child, you can fund the account using your linked bank account and then make your investment selections. As the custodian, you choose how the money in the IRA is invested, though you might want to talk to your kids first to get their feedback. Generally, custodial IRAs can offer the same investment selections as IRAs for adults, which can mean stocks, mutual funds, exchange-traded funds (ETFs), bonds and other securities.

Different Types of IRAs for Children

As mentioned earlier, there are two main types of IRAs you can open for a minor child: traditional and Roth. The main difference lies in their tax treatment. The IRS regulates contributions to and withdrawals from each type of IRA.

Traditional IRA

A traditional IRA is funded with pre-tax dollars. The IRS allows eligible taxpayers to claim a deduction for contributions. When you take money out in retirement, you pay taxes on the earnings.

Traditional IRAs can make sense for people who can benefit from tax-deductible contributions. That might be less valuable to your child than the tax benefits that a Roth IRA could yield.

Roth IRA

You start a Roth IRA using after-tax dollars, so you get no tax deductions on your contributions. But they can offer something else: tax-free qualified distributions. This means no matter what tax bracket your child is in when they retire, they can withdraw their money from a Roth IRA tax-free.

Roth IRA withdrawal rules also allow contributions to be withdrawn at any time, tax- and penalty-free.

Funding a Child’s Retirement Account

Both traditional and Roth IRAs have annual contribution limits, and you have to contribute earned income. For 2023, the IRA contribution limit is $6,500. If you’re 50 or older, you can add another $1,000 to help you catch up for retirement.

The same rules apply to custodial IRAs. In 2023, kids can contribute an amount equal to their earnings for the year or the $6,500 limit, whichever is lower. So if your child makes $5,000 by babysitting and mowing lawns, the most they’d be able to add to their IRA is $5,000.

Again, it’s important to remember that kids need to have income (specifically, taxable compensation) to open and contribute to a traditional or Roth IRA. According to the IRS, that includes:

  • Wages
  • Salaries
  • Commissions
  • Tips
  • Bonuses
  • Net income from self-employment

Investment income, including interest and dividend income, doesn’t count as income that can be contributed to the child’s IRA, under IRS guidelines.

Can a Parent Contribute to a Child’s IRA?

A parent can contribute to a child’s IRA only if that child has earned income of their own for the year.

Again, contributions to a child’s IRA must not exceed their allowed limit for the year. Going back to the previous example, in which your child earned $5,000, they could technically put all of that money into their IRA. Or you could offer to split the difference and let them put in $2,500 while contributing the remaining $2,500 yourself.

Keeping careful records of your child’s earnings for the year can help you avoid contributing too much to their IRA. Also, offering to put in an equivalent amount (without breaching the limit) can be a good motivator for kids to invest in their IRA.

Benefits of a Child Opening a Retirement Account

Opening up a Roth IRA for a child can benefit them in several ways.

  • Kids can get an early taste of what it means to invest money rather than saving it. The IRA can be a teaching tool to help a child learn how the market works and the importance of setting long-term financial goals.
  • Kids who start saving for retirement at an early age have the ability to take full advantage of the power of compounding interest. A child who contributes $5,000 each year starting at age 14 and earns a 7% annual return, for example, could have $2.3 million saved for retirement by age 65. Running the numbers using a Roth IRA calculator can give you an idea of how much of a head start on growing wealth you might be able to give your child by opening a minor IRA.
  • The money in a Roth IRA for a child is tax-free when they take qualified distributions. This can result in substantial tax savings if they’re in a higher tax bracket when they retire.

Cons of a Child Opening a Retirement Account

Before you open a traditional or Roth IRA for a child, there are some drawbacks to consider.

  • While contributing to a Roth IRA may offer some long-term benefits, there are no guarantees, and the money is then locked up until your child turns 59 ½ (although early withdrawals are possible, and might incur a penalty).
  • A Roth IRA might affect your college-bound child’s financial aid eligibility. Just having money in a Roth IRA won’t cause any snags if your child is applying for federal student aid. But if they withdraw contributions from their Roth IRA for any reason — including paying for college expenses — that money is counted as income, which may affect eligibility for need-based aid.
  • Investments within a custodial IRA entail some level of risk, as with all investments.

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How to cut costs now for a better retirement later

More than 6 in 10 Americans aren’t on track with their retirement savings, according to the Federal Reserve. If you’re getting close to retirement age and still working on your nest egg, you might have concerns about running out of funds when you’re supposed to be relaxing and enjoying life.

One way to ease money anxiety when it comes to retirement is to start cutting costs now. If you live a frugal lifestyle before and during retirement, your savings will be more likely to last to the end of your life.

Many people downsize their home to cut costs, but fewer people consider other clever ways to reduce expenses. Every expense you budget for, whether that’s groceries or gas, presents an opportunity to save more. Here are 13 areas where you can downsize your spending prior to retirement and the simple ways to do it.

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You don’t need to spend hours clipping coupons to save money on groceries. Grocery store rewards apps, such as Ibotta, will give you cash back just for scanning your receipts or even using a linked credit card. And if you use one of the best credit cards for buying groceries, you can stack the cash back. Some cards can earn as much as 6% back on grocery store purchases.

In addition, make a grocery list and stick to it to help reduce unexpected costs. Buying in bulk while items are on sale is another great way to save money on groceries. You can also compare prices at different stores. Although it might be easiest to get all your groceries in one spot, you could save by shopping for specific items where they are cheapest.

Related: The best states for retirement if you care about taxes

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One way to lower your internet bill is to negotiate with your provider. Call them up and let the customer service representative know you’ve been shopping around for deals from other providers and are thinking of switching. You might have to agree to a new contract, but you’ll likely get a lower rate. If you don’t want to be tasked with doing this yourself, you can download an app like Truebill to do the work for you.

In addition, you might purchase your own modem and router, as this can save you money over time. Although the monthly cost to rent this equipment from your internet provider is fairly cheap, it can add up in the long run. And don’t let your internet provider talk you into upgrades you don’t need.

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Truebill can also help lower your cell phone bill if you don’t want to handle negotiations yourself. Another great way to reduce costs is with a family or group plan. The price per line generally decreases as you add more lines, so getting a plan with friends or family members can help you keep costs low.

You should also pay attention to your usage and make sure you have the most cost-effective plan. For example, if you’re getting charged overages each month for your data usage, you should probably opt for an unlimited plan instead. On the other hand, if you can reduce your data usage and switch to a lower-priced limited plan, you’ll save money on your monthly bill.

Using an app like GetUpside can help you both compare prices at local gas stations and earn cash back when you fill up. This can save you up to 25 cents per gallon. You can also stack those savings with cash back if you use one of the best credit cards for gas.

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In addition to using a rewards credit card for your shopping, you can earn money by using cash back apps every time you shop. You have many great options to choose from, including Fetch, Drop, Shopkick, Rakuten, and more.

    You can try out multiple apps for your shopping, but you’ll be able to use only one for each purchase. Choose the app with the highest cashback offer for the retailer you’re shopping with. Some apps reward you with useful gift cards to stores like Target and Amazon, whereas others provide you with cash. They’re simple to use — you’ll typically either click a link before making your purchase or use a card linked to your account.

    Retail cards and cashback cards are another great way to save on your shopping. Although you shouldn’t have a retail card for every store you shop at, you can apply for the most lucrative ones based on what they offer and where you shop the most. Also pay attention to senior discounts available at many retailers.

    monkeybusinessimages / istockphoto

    It’s generally a good idea to shop around for new car insurance quotes every six months. That’s because circumstances can change, and so will your rates. For example, if an accident falls off your driving record or you move to a new location, you might find you can get a cheaper premium just by switching providers.

    The best car insurance companies also provide discounts that could reduce your rate, so be sure to ask what you’re eligible for. They typically range from good student discounts to good driver discounts to multi-policy discounts, so there’s often a way to save money that can apply to you.

    jacoblund / istockphoto

    Cutting the cord on your cable bill can be a great budgeting strategy, but not if you spend a fortune on streaming services instead. Decide which services you’ll use the most, and then get a group of family members, roommates, or friends together to share an account. Most streaming services allow you to create profiles for multiple users. Note that you can also access plenty of free content with your library card via hoopla or Kanopy.

    You should also use one of the best credit cards for streaming services, for any service you’re paying for. It’s possible to earn easy cash back on your Hulu, Netflix, and other subscriptions just by using the right card.

    Deposit Photos

    If you still have debt heading into retirement and you’re paying high interest on your credit cards, consider adopting a strategy that could help you get out of debt more quickly, like the debt avalanche method.

    You could also use one of the best balance transfer credit cards to take advantage of a 0% introductory APR offer. You can typically get a 12-18 month break from interest by transferring your debt to one of these cards, That means you’ll be able to devote more of your income toward paying down principal, which will help you eliminate debt faster.

    If you’re still paying unnecessary maintenance fees at your bank, it may be time to open a new account. Many of the best checking accounts and best saving accounts don’t charge any fees. You might even be able to accrue some extra interest by switching to a high-yield savings account.

    Even if you stay with your current bank, be sure you’re opted out of overdraft protection. The Consumer Financial Protection Bureau found that opted-in customers pay seven times more in non-sufficient funds and overdraft fees than opted-out customers. That’s more than $200 per year you could save with this one simple move.

    It’s typically advisable to pay off your mortgage before you reach retirement. That’s because you’ll have less income to put toward a mortgage payment. So if you still owe money on your mortgage, the opportunity to take advantage of a low interest rate might be among the reasons to refinance your mortgage.

    With the right refi, you could save money over the life of your loan and even shorten the term. Just be sure to do the math to make sure the interest rate reduction is worth the fees and time involved.

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    There are steps you can take to make your home more energy efficient and save money on your utility bills. The bonus? Some upgrades may actually add value to your home when it comes time to downsize. For example, you might purchase more energy-efficient appliances or install low-flow toilets.

    Related: Study offers clear picture of Americans’ retirement savings


    Be mindful of how you travel as you prepare for retirement. If you’re accustomed to taking multiple vacations per year, you may want to replace one with a staycation to save a little more. When you do travel, be sure to use one of the best travel credit cards. Many of these come with attractive signup bonuses that can help you afford your next vacation, as well as perks like free checked luggage or airport lounge access.

    If you’re thinking about downsizing in the near future, now’s the time to declutter your home by selling or donating belongings you no longer use.

    You might be surprised by how easy it is to turn your old stuff into extra cash. You could earn money by hosting a garage sale or listing items on local marketplaces such as Facebook and OfferUp. You can even sell your used clothing on Poshmark or make extra cash online from your old books and electronics.

    If you’ve had difficulty with how to manage your money in the past, it’s not too late to get on the right track. You might consider using one of the best budgeting apps to help you reduce costs, save more, and pay off debt. Many are free to use and could be beneficial as you head into retirement.

    While you’re still earning income, you might also do your best to boost your retirement savings as you trim your expenses. A frugal lifestyle now will lead to a more comfortable retirement later on.

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