The Kiddie Roth is not an official IRA term. It’s my way of highlighting one of the uses for the Roth Ira that I will call a “no-brainer.” You see, unlike the Kiddie Tax, which limits how much investment income a child can have before requiring them to pay at the parents’ rate, the Kiddie Roth is an opportunity for your child to stash money away, and never, ever pay taxes on it. Never. How’s that?
Your dependent (in this case your child, the younger, the better) doesn’t get an exemption, you benefit on your tax return by taking an exemption for each family member, so your child doesn’t get his own. But, he does get a standard deduction, $5,950 in 2012. To be clear, his standard deduction is actually $950 or his earned income plus $300, but not to exceed that $5,950 figure. The result of this is the fact that the kid has the opportunity to open a Roth IRA and deposit up to $5,000 or his total income whichever is less. Many children are getting jobs bagging groceries or delivering newspapers at 14 or so. But it’s not unheard of for kids to earn money at an even younger age. My daughter started baby sitting and mothers’ helping when she was 11 years old. Of course, she wasn’t so willing to take this money and lock it up for decades, but we had other money in her name, and shifting it to a Roth with an eye toward the future really made sense. Looking backwards, the market has grown nearly 10% over the last 80 years. If we get 8% in the decades to come, this money will double every 9 years. This is the Rule of 72, in case you missed it. After 45 years, she’d be 56, and the money will have seen 5 doublings, or each $1000 deposit will grow to $32,000. Inflation will surely knock it down a bit, but it should still be worth $10,000 or more. I’m hoping that if we give our kids a head start like this, they won’t be like those in Jim Wang’s article Average Retirement Savings by Age. There he cites the average 55-64 year old as having only $69,000 in retirement savings. With 10 years of deposits from age 11 to 20, averaging $3000 per year, that $30,000 deposited might be worth $40,000 when my daughter graduates college, nearly as much as the average 45-54 year old has saved.
When I started to discuss this among friends, readers, and tweeps, I was told their broker wouldn’t open a Roth for their minor child. To them I say, time to change brokers. I use Schwab, and they offer an account specifically designated as a Custodial IRA.
FTC disclaimer – I mentioned Schwab in this article. I received nothing in return for the mention. They are welcome to send me a sweatshirt, men’s large if they start to see a huge rise in Custodial IRA applications. In my regular life, Schwab has treated me well, but they don’t know I’m Joe.