What Is a Guardian IRA?

A Guardian IRA is an Individual Retirement Account held in the name of a legal guardian or parent on behalf of a child or other person under the age of 18-21 (depending on state legislation) or an individual who is incapable of handling their own finances due to a physical or mental disability. This is also called a custodial IRA.

Understanding Guardian IRA

The guardian is responsible for signing documents on behalf of the minor or special-needs adult. The responsibilities of the guardian cease once the child is no longer a minor or when the adult is able to handle his or her own finances.

Benefits of Guardian IRAs

There are two different types of IRAs that are suitable for children: traditional and Roth. The primary difference between traditional and Roth IRAs is when you pay taxes on the money contributed to the plan. With a traditional IRA, you pay taxes when you withdraw the money during retirement (at your then-applicable tax rate). A traditional IRA contains pre-tax earnings. With a Roth IRA, the money put into the account has already been taxed, so it contains after-tax earnings.

The money grows tax-free while it’s in either a traditional or Roth IRA. But the benefit of a Roth is that when the child withdraws the money many decades later, he or she won't have to pay income tax on it. What's more, there are currently no required minimum distributions (RMDs) on Roth accounts. Of course, these rules may change any time based on government legislature.

As the custodian, you (the adult) control the assets in the custodial IRA until your child reaches age 18 (or 21 in some states), at which point the assets are turned over to him or her. The IRA is opened in your child’s name, and you will have to provide his or her Social Security number when you open the account.

IRAs make sense for kids who have enough earned income that they would have to file income taxes. Note that for 2020, the standard deduction goes up to $12,400 for an individual, from $12,200 in 2019, so kids could make that much and not have to pay any federal taxes, though they would still have to file a return.

Converting a traditional IRA to a Roth may make sense for kids, especially in years when they have little to no income. They could convert up to the standard deduction each year and pay little to no federal taxes.