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Thinking Ahead: A parent’s guide to setting up an IRA for your kids.

IRA child

Given the chance, what parent wouldn’t want to help secure their child’s financial future? That may seem like pie-in-sky dreaming for many middle and lower-income families, but it’s really not. As a parent, there actually is something you can do that can help to secure their future financial security: open and fund a ROTH IRA for your kid.

An Individual Retirement Account (IRA) isn’t just for adults—children who earn income can also benefit from this powerful investment tool. In this guide, we’ll explore how parents can establish an IRA for their children, enable them to capitalize on long-term growth and tax advantages, and empower them to build a substantial nest egg (which they can later use as a downpayment on their first home or for their retirement).

 

Why Open an IRA for Your Child?

The magic of compound interest means that the sooner one starts saving, the more significant the potential financial reward. Starting an IRA for your child not only sets them up for a secure retirement, but can also teach them valuable financial lessons early on. Moreover, both traditional and Roth IRAs offer tax advantages that can enhance earnings from these accounts over time, making them excellent vehicles for long-term savings. While traditional IRAs offer tax-deferred growth, Roth IRAs provide tax-free growth and withdrawals, often making them more suitable for the long investment horizon of a child or teen.

 

Eligibility and Requirements

Any child with earned income from a job, such as babysitting, a paper route, or part-time employment, can have an IRA. Parents or guardians can open a custodial IRA account, which they will manage until the child reaches adulthood.

How to Set Up an IRA for Your Child

Setting up an IRA for your child involves several steps:

  1. Choose the Right Institution: Look for credit unions, banks, or brokerages that offer custodial IRA accounts with low fees and a good selection of investment options.
  2. Select Appropriate Investments: Within the IRA, choose investments that align with long-term growth objectives, such as mutual funds or index funds.
  3. Open a Custodial Account: This account will be managed by the parent until the child reaches the age of majority.

Contributions and Growth

For 2024, the annual contribution limit to an IRA is $6,500. Consistently contributing to your child’s IRA can significantly impact their financial health in the future. Even if you start small, regular contributions can grow exponentially thanks to compound interest.

Practical Advice on Contributing to Your Child’s IRA

To effectively build your child’s retirement savings, consider these strategies:

  • Maximize Contributions: Whenever possible, contribute the maximum amount annually to your child’s IRA.
  • Automate Savings: Set up automatic transfers to the IRA to ensure steady savings.
  • Engage Your Child: As they grow older, involve them in managing their IRA to teach them about investing.
  • Regular Reviews: Check the performance of the IRA annually and adjust strategies as needed to maximize growth.

Growth Over Time

Consider three scenarios where you contribute the maximum amount for five years at different stages of your child’s life:

  • Starting at Age 5: Contributions total $32,500. Assuming a 7% annual return, this could grow to approximately $536,000 by age 65.
  • Starting at Age 10: The same total contribution could grow to about $380,000.
  • Starting at Age 15: Starting later could result in approximately $270,000 by retirement.

Those numbers are for just five years of contributions and don’t include subsequent contributions made by you or your child.

Don’t Wait

Setting up an IRA for your child is a profound step towards their financial independence and security. The benefits of starting early cannot be overstated, as demonstrated by the substantial differences in potential outcomes over time. By prioritizing this aspect of their financial education, you not only enhance their future financial well-being but also instill crucial saving and investment habits that will serve them throughout their life. That’s a true gift.

Give Your Child a Head Start at Lafayette Federal

At Lafayette Federal, we offer your family the tools, resources, and financial solutions you need to ensure your children get a head start on their financial roadmap, including a variety of IRA options. Getting them financially established is one of the best gifts you can provide to them. Set up an account in minutes to begin their financial journey today!

Not a Lafayette Federal member yet? You can become a member by completing an online membership application.

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