Can Teenagers Open a Roth IRA? Here’s Why They Should

Yes, teenagers can open a Roth IRA. In this post we'll explore how and why investing in a Roth IRA can be extremely powerful for kids.

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What Is a Roth IRA?

First let's do a brief recap of what exactly a Roth IRA is.

A Roth IRA is simply a retirement savings vehicle that was established in 1997 to help U.S. citizens save for retirement. It is an individual retirement account wherein contributions are made with after-tax money, and growth and future withdrawals are tax-free.

Why Should a Teenager Be Interested in a Roth IRA?

Retirement is probably the last thing on a teenager's mind. Why would they be interested in opening a Roth IRA?

So first, a lot of people probably don't realize that there is no age requirement to open a Roth IRA. Technically, a baby could open one …if they have earned income, which is unlikely. But maybe they're a baby child actor. Earned income is the only requirement. That summer job babysitting, lifeguarding, or mowing lawns makes them eligible for a Roth IRA.

Don't try to abuse this, though. You can't pay your kid $500 an hour for washing the dishes and call it earned income. Ideally the child will receive a Form W-2 from the employer to validate their earnings. If your child is not filing taxes, keep good records of payment history in case the IRS comes knocking.

What's more, the IRS doesn't even care where those cash contributions come from. Convincing kids to save for retirement can be extremely challenging when their immediate financial concerns are likely things like video games, Starbucks, and fast food. Thus, an adult can contribute to their child's Roth IRA, provided again the child has earned income in that year equal to or greater than the amount of those contributions.

For example, the teen may earn $5,000 during the year from their job and the parent may choose to contribute $5,000 to their child's Roth IRA, allowing the teen to spend or save their $5,000 how they wish. In this way, savvy adults can provide a major jumpstart for their child's financial future without the teen even really being involved.

One of the reasons this is extremely valuable is because of the power of compound returns. Just a few extra years can make a huge difference in the final value of one's portfolio at retirement, particularly because a teenager likely has multiple decades before retirement.

An investment of $5,000 annually over 40 years with a 7% annualized return will grow to about $1.1 million. Add just 5 more years and that final amount changes to roughly $1.6 million, an increase of about 45%. The earlier they get started, the greater that nest egg can grow.

Another reason the Roth IRA can be particularly powerful for a teenager is because they might easily have a higher tax rate in retirement, as most teens pay little to no income tax. With the Roth IRA, their withdrawals in retirement are tax-free. Contributions can also be withdrawn anytime tax- and penalty-free, offering valuable flexibility.

Lastly, while custodial taxable brokerage accounts also exist, the Roth won't impact the teenager's eligibility for financial aid.

Roth IRA Income and Contribution Limits

Teenagers usually don't have extremely high incomes, but it's worth noting that eligibility is determined by Modified Adjusted Gross Income (MAGI) level, and there are also annual contribution limits.

At this time in 2023, the annual contribution limit for individuals for a Roth IRA is $6,500 if below age 50 and $7,500 if age 50 or older, up from $6,000 and $7,000 respectively for 2022. Remember that the annual contribution cannot exceed the earned income for that year.

The current annual income limits to be eligible to contribute to a Roth IRA in 2023 are $153,000 if single and $228,000 if married filing jointly. Phase-outs for reduced allowed contributions begin at $138,000 if single and $218,000 if married filing jointly.

Here's a recap of those limits in a table:

Rules	Limit
2022 Contribution Limits	$6,000; $7,000 if age 50 or older.
2023 Contribution Limits	$6,500; $7,500 if age 50 or older.
2022 Income Limits – Single	$144,000; phase-out begins at $129,000.
2023 Income Limits – Single	$153,000; phase-out begins at $138,000.
2022 Income Limits – Married Filing Jointly	$214,000; phase-out begins at $204,000.
2023 Income Limits – Married Filing Jointly	$228,000; phase-out begins at $218,000.

How To Open a Roth IRA for Kids

To open a Roth IRA for kids, an adult must open what's called a Custodial IRA if the child is a minor (usually under the age of 18 in the U.S., depending on the state).

This account is functionally the same as a “regular” Roth IRA except the adult controls the assets until the teenager reaches the age of majority (again, usually 18 in the U.S. in most states). At that point, the account belongs to the child and they can continue to contribute to it.

A significant benefit here is that this custodial relationship allows the adult to be in charge of choosing investments for the IRA, which is important in the age of gamification of addictive stock picking apps like Robinhood that prey on young brains. The adult can thus utilize low-cost, broadly diversified index funds and introduce the child to the powers of saving and index investing to get them started on solid ground before they start investing on their own.

I would encourage you to use this opportunity to make this account part of a larger conversation with your child about basic financial literacy – goals, budgeting, managing expenses, having an emergency fund, etc. This will set her up for financial success more than you may realize, and while she may think those topics are boring at the time, she'll be thankful for those conversations in the future.

If she expresses interest, this also opens the door for discussions about specific investing concepts like diversification, the folly of market timing, and risk. This will also prepare her to take the reigns on the account when she is no longer a minor.

Most brokers (like Vanguard, Schwab, and Fidelity) offer Custodial IRAs, but not all of them.

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Does your kid have a Roth IRA? Are you thinking about opening a Custodial IRA for them? Let me know in the comments.

Don't want to do all this investing stuff yourself or feel overwhelmed? Check out my flat-fee-only fiduciary friends over at Advisor.com.

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