Can I open an IRA for my three children ages 9,8 and 5?
I am 41 years old and I am just learning what an IRA is. My parents never explained to me about retirement, however I want to make an investment in my children's future. As I've been reading, I see that there is the traditional IRA and the Roth IRA, but I'm a little bit confused and I want to know what type of account I can open for my young children.
Your children can only contribute to an IRA if they have a "job". To contribute to an IRA you have to have earned income. Once your children start earning money (and reporting it on a tax return) you can contribute the lesser of $5,500 or their earned income to an IRA. If/when they do have earned income a Roth IRA may be the best option.
But...don't short change your own retirement to support theirs.
While it might be possible to open and fund a child's IRA (when they have earned income) I think a better option might be for you to open college savings accounts for them instead. The basic college savings account is usually referred to as a 529 plan. Depending on which state you live in you might be eligible for a state tax deduction.
The 529 plan is a way to invest for college and, when the time comes, the withdrawals for qualified education expenses are tax-free. With children in this age group, a 529 plan will really provide a nice amount of time for the account to build value.
But, like it was already mentioned, make sure to take care of your retirement first. Kids have options for paying for college (loans, grants, scholarships) but you can't get a loan to retire...
In order to contribute to a traditional IRA or Roth IRA, your children will need to have earned income for the year, which of course they do not. Your options though to help them start saving are a Coverdell IRA or 529 Plan, which is used exclusively for higher education expenses and custodial accounts (UTMA or UGMA).
A Coverdell IRA is a tax-advantaged savings account to help cover secondary (private high school) and higher education (college) expenses. You are allowed to contribute $2,000 per year. Contributions will grow tax-free until distributions. There is the possibility that you will not pay taxes on contributions if for any given year education expenses were more than total distributions taken from the account. You are only allowed to set up this account for each child if your own Modified Adjusted Gross Income (MAGI) is $110,000 or less if you are single and $220,000 if you are married filing jointly.
A 529 Plan is also a tax-advantaged savings account that works in a similar way to a Coverdell IRA except there are no restrictions in terms of MAGI and all distributions are tax-free as long as they are used for higher education expenses. You are allowed to contribute as much as you want to a 529 Plan in any given year, but the maximum allowable contribution limit to any one 529 Plan ranges from $235,000 to $400,000 depending on the type of plan. There may be additional tax benefits for a 529 plan depending on your state of residence. There is a 10% penalty on all distributions not used for higher education expenses.
A Uniform Transfers to Minors Act (UTMA) account is a custodial account set up by an adult (YOU) for the benefit of a minor. It doesn’t necessarily have to be a parent. It qualifies as part of the gift tax exclusion. The account can receive gifts such as money, patents, royalties, real estate, and fine art, without the aid of a guardian or trustee. The custodian (adult) manages the account until the minor reaches adult age (18 or 21) depending on your state of residence. The account is irrevocable in the sense that once gifts are made to the account, they cannot be taken back. Because the assets in the account are owned by the child, earning in the account are usually taxed at the child’s (lower) tax rate. Also keep in mind that the assets in a child’s UTMA account can have an effect on the amount of financial aid they will receive for college.
A Uniform Gifts to Minors Act (UGMA) accounts are similar to UTMA accounts in every way except the law limits gifts/transfers to bank deposits, securities (including mutual funds), and insurance policies.
A UTMA and UGMA account gives your more flexibility in terms of what the assets can be used for. If you know the college is a goal for you and your child, a 529 Plan is usually the best way to go.
We also suggest that you work with an independent Wealth Advisor to determine how the assets should be invested.