A Roth IRA is a special retirement account that allows participants to receive tax-free income in retirement. There are no age restrictions; therefore, a child can have a Roth IRA account and get a great head start on both their retirement savings and wealth-building goals.
It is important to know that a child must have some earned income to contribute to a Roth IRA, but anyone can also contribute on behalf of an eligible child. The IRS will consider earnings from a part-time afterschool job or summer working experience as eligible to be invested in a Roth IRA. However, savvy business owners might also hire their children to help with filing, cleaning, or other tasks that allow the owner to help their child get this huge leg up on retirement savings.
When your child adds cash to their Roth IRA account, they do not get any tax breaks — which would not be valuable to them, in any case, as children’s tax rates are typically very low. However, the valuable tax benefits come on the back end. Your child will be able to withdraw their contributions and earnings 100% tax-free once they are over age 59½ (based on current rules). Both the investment made and all the interest, dividends, and growth on these assets escape the clutches of Uncle Sam and will accumulate a nice pot of cash over time.
If your child needs access to the investment account sooner, they can withdraw their contributions tax- and penalty-free for any purpose, if they have owned the account for at least five years. Children have decades for their Roth IRA contributions to grow, tax-free. The power of compounding works by exponentially increasing the account’s value. So starting while the child is young exponentially increases the benefits of compounding.