If you have a Roth IRA, you probably already know it's a great way to save for your later years. But what if you want to help a loved one kickstart their retirement fund—can you open a Roth IRA for someone else?
Every holiday season, children across the country rip open gifts on a short-lived magical morning. Unfortunately, most of those gifts will long be used up or forgotten. But this year, you could give a gift to someone that could literally change their life forever: a tax-free retirement. It requires only a small upfront investment, and it can pay out a much larger amount—multiplying many times over.
How can you provide someone with this amazing gift? Give them a Roth IRA. It's one gift that truly keeps on giving.
- Roth IRAs make great gifts for children and teenagers because they can take full advantage of time and compounding.
- You can give a child a Roth by establishing an account in their name, and helping to fund it.
- Anyone with a Roth IRA must have earned income during the year that a contribution is made to the account.
- You can also give someone a Roth IRA by designating them as your account beneficiary.
- Make sure you speak to your kids or grandkids if you can't afford to help fund a Roth IRA account or they don't meet the qualifications.
Open a Custodial Roth IRA
There are a handful of ways you can gift a Roth IRA, including opening up a custodial account for a minor. Let's say you're a parent or grandparent who wants to help kids secure their financial futures. Instead of just telling them about Roth IRAs, you could start one for them in their name.
Since they’re minors, it has to be a custodial account. An increasing number of brokerages offer Roth IRAs for kids. Some of these firms even waive or reduce the usual account minimums to set one up. A Roth IRA can help save not just for retirement, but for college or a first home, as well.
The Roth may even encourage the child to get a job or even start a little side business so they can add money to the account. You or someone else can also contribute gifts directly to it.
If you contribute to someone else's Roth IRA, that money will count against your limit on tax-free gifts you can give one person annually. For 2021, that's $15,000.
The Earned Income Requirement for Roth IRAs
You have to be very careful if you help fund an IRA for a minor child. Why? Because anyone with a Roth IRA must have earned income during the year that a contribution is made to the account. And you can keep making contributions up to the annual limits no matter how old you are, as long as you meet that earned income requirement.
That earned income can come from part-time jobs like babysitting or working at the grocery store. Odd jobs are okay, too, but the wages have to be reasonable. Are you okay with $25 to weed the garden? Sure. But you can't get away with paying your grandkids $1,000 to mow the lawn.
Here's another consideration. The contribution amount is limited by the amount of the account holder's earned income. If your grandson earned $2,500 working during the year, he (and you) can only contribute that much, even though the overall contribution limit is $6,000 for 2021 and 2022.
Still, there's no stipulation in the Internal Revenue Service (IRS) guidelines that says the $2,500 he invests in the Roth IRA has to come directly from his earnings. He can earn $2,500 and spend it on a mountain bike and car insurance if he so desires. This means you can give him a gift of $2,500 to put into the Roth IRA. Just make sure the amount you give doesn’t exceed what he earned.
Name a Beneficiary for Your Roth IRA
Another way to gift a Roth IRA to someone is to make them the beneficiary on your account. You do this simply by designating them as such on your Roth IRA forms. A spouse is a usual choice, but anyone of any age can be a beneficiary or co-beneficiary.
Bequeathing a Roth is an increasingly popular tool in estate planning. One reason is that Roth accounts don't have required minimum distributions (RMDs). This means if you don't need the money, you can keep it in the account to continue growing.
Another reason Roths are popular for estate planning is that proceeds don’t have to go through probate, as bequests from a will do. The Roth passes directly to the beneficiary, which can save a lot of time and money.
A spouse who is a sole beneficiary can elect a spousal transfer and treat the IRA as if it were their own. Children or other non-spousal beneficiaries who inherit a Roth are required to start withdrawing funds from it, according to IRS-specified amounts and timetables. But they won’t owe income tax on them, provided the Roth was at least five years old at the original owner's death.
Either way, you can set up a loved one with years of tax-free growth and income when you bequeath your Roth IRA.
Offer an Education
You don’t have to actually hand a wad of cash to someone in order to give the gift of a Roth IRA. Instead, you can share with them everything they could ever want to know about the account and IRAs in general, such as:
- Whether they can contribute based on their income
- How much they can contribute based on their age
- How Roth IRA taxes work
Simply sitting down with them and going over all the massive potential benefits of opening and regularly funding a Roth IRA is a huge gift.
You may not be able to afford to help fund the account for them, or they may not meet the qualifications just yet. That’s fine. Improve their financial literacy, and answer as many questions as you can. Igniting the flame of curiosity is a great start.
The Bottom Line
A Roth IRA may not be the most exciting gift out there. But it's one that your loved ones will benefit from for years or decades to come. And that makes a Roth IRA a gift that truly keeps on giving.