Since the Roth IRA was first introduced in 1997 there have been long debates and discussions about whether to use it or a “regular” IRA. The conversation becomes further complicated when converting longtime IRAs to Roth IRAs. We recently stumbled across a flowchart developed to walk thru the Roth contribution dilemma and found that it could take as many as 12 questions to get to a decision on eligibility.

Fortunately the decision to contribute to a Roth IRA for a minor child or grandchild is a pretty simple one.  Does the child have earned income? If the child does have earned income then we view opening a custodial Roth IRA as a pretty good idea. Here are some of the pros and cons of proceeding.

Pros

  • A Roth IRA is more flexible than other retirement accounts because contributions can be withdrawn at any time tax-free, and used for anything.
  • Since the child is starting so young, the “miracle” of compound interest works dramatically on his or her behalf.
  • Roth IRAs offer more robust investment opportunities than deposits to a child’s bank savings account.
  • While there is no income tax break for the contribution to a Roth IRA, the payoff is on the other end: all earnings will be income tax-free as long as the child follows the distribution rules.
  • There are a couple of loopholes that allow the child to tap the earnings prior to age 59 ½ without penalty.
    • After the account has been funded for five years, up to $10,000 of earnings can be taken out to purchase a first home tax-free and penalty-free.  Note that this is in addition to contributions, which can be withdrawn at any time.
    • Roth IRA earnings can also be withdrawn for qualified higher education expenses penalty-free, but income taxes must be paid.
  • Finally, if a child struggles to save their own earned income, a parent can gift the funds to the child (with limits) in order to make contributions to a Roth IRA.

Cons

  • Withdrawal of Roth IRA earnings (the return on contributions) is not as easy as withdrawing the contribution itself. Depending on when they are accessed, distributions of investment earnings may be taxed as income, penalized with a 10% early distribution fee, or both.
  • Dollars invested in a Roth IRA are subject to market fluctuations. Your kids could lose the money they invest in a Roth IRA, though history tells us that’s unlikely to happen as long as they stick to a diversified portfolio over a long period of time.

For questions on Roth IRAs for minors, or any other investment, savings, or wealth transfer strategy, call your SYM advisor or visit us at sym.com. You may also be interested in another SYM paper, Roth IRAs for Kids and Grandkids, which explains the investment strategy in further detail.

Disclosure: The opinions expressed herein are those of SYM Financial Corporation (“SYM”) and are subject to change without notice. This material is not financial advice or an offer to sell any product. SYM is an independent investment adviser registered under the Investment Advisers Act of 1940, as amended. Registration does not imply a certain level of skill or training. More information about SYM including our investment strategies, fees, and objectives can be found in our ADV Part 2, which is available upon request.