Creating a Roth IRA for Your Teen

Creating a Roth IRA for your teen can be a valuable way to provide for them while maximizing the annual gift tax exclusion and reducing the size of your taxable estate. While Roth IRAs are generally known for their retirement saving benefits, they can also be a great vehicle for saving for college, a down payment on a home, emergency funds, or the birth of a child—all tax free! If your teen does choose to use the account for retirement purposes, your contributions can be a powerful tool for legacy planning, providing a substantial nest egg and potentially benefiting future generations.  

What is a Roth IRA and what can it be used for?  

A Roth IRA is an individual retirement account that you fund with after-tax dollars based on your annual income. While the funds are taxed initially on the front end, they can grow tax-free and be withdrawn for any purpose tax-free with no penalties after (1) age 59 ½ and (2) once the account has been open for at least five years. There are several exceptions, however, to allow for early withdrawals without a penalty. There are no mandatory withdrawals (unlike a traditional IRA), but there are limits to how much money can be contributed. 

What are the benefits of opening a Roth IRA for a teen? 

Money contributed to a Roth IRA grows tax-free! The earlier you begin contributing to a Roth IRA, the more years the funds will have to compound in growth. This can be a huge jump start for teenagers starting to save early—time is on their side. The money you contribute to your teen child or grandchild’s account will go further than an outright gift of cash with lasting long-term growth. Additionally, creating a Roth IRA can provide early valuable lessons about the importance of saving and investing, as well as help establish healthy financial habits early that can serve them for the rest of their life.

How can a Roth IRA be used other than saving for retirement? 

Generally, if the account holder withdraws funds early (before reaching age 59 ½), there is a 10% early withdrawal penalty. However, there are some important exceptions to this rule that allow for tax-free withdrawals as long as the account has been open for at least 5 years: 

• Qualified Education Expenses 

• First-Time Home Purchase  

• Disability 

• Birth or Adoption of a Child 

• Health Insurance Premiums 

Additionally, any money left over from a 529 education savings plan can be rolled over into a Roth IRA to take advantage of tax benefits. Overall, a Roth IRA can be a valuable tool for encouraging responsible use of the account funds regardless of whether the account is used purely for saving for retirement! 

Does my teen qualify for opening a Roth IRA? 

The requirement for opening and contributing to a Roth IRA is simple: earn income! There is no minimum age requirement, and the manner of earning can be as modest as dog walking, babysitting, tutoring, lawn mowing, or lifeguarding. Any teen earning taxable income can qualify as long as their income is reported for tax purposes.  

How much money can I contribute to the account? 

As of 2024, the maximum annual contribution limit for a Roth IRA is $7,000 or the amount of earned income the teen earns in a year, whichever is less. If you’re contributing $7,000 to the account each year, you can still gift the teen an additional $11,000 (as of 2024) a year outright in addition to the contribution to maximize the annual gift tax exclusion and diminish your taxable estate. And remember, if you are married, you and your spouse can double your annual gift tax exclusion—meaning that you could annually gift the child $29,000 in addition to the $7,000 Roth IRA contribution.  

And that’s for each individual teen in your life! The benefits for your estate planning can add up quickly.  

Give us a call at (512)374-4922 to talk to our estate planning attorneys about setting up a Roth IRA for the teenager in your life!