One of the most valuable gifts a parent can offer their children is a head start in saving for retirement. Now that savings boost is getting easier to provide, as more fund companies roll out Roth IRAs specifically designed for kids.
Fidelity, a top fund company, recently joined Schwab and a handful of others by launching a kid-friendly IRA account. The firm’s entrance into this market underscores the importance of an early start, and reflects growing demand from parents for savings options for their children.
The Roth IRA for kids works much like a regular Roth IRA—it's funded by after-tax savings, and the account grows tax-free. But there are a couple of exceptions: the kiddie Roth is a custodial account for children under the age of 18, and it's funded and controlled by an adult, typically a parent or grandparent. Control is transferred to the child when they become an adult. A child 18 or older can open a regular Roth at Fidelity. Previously, Fidelity did not allow Roth accounts for anyone under 18.
As with a regular Roth IRA, the saver must have earned income to fund the account. I have long been a proponent of parents using a Roth to set up a kind of family 401(k) plan. Parents agree to match some or all of the money their kids earn at a summer or part-time job. Now that money can be stashed in a kiddie Roth where it will grow tax-free as long as they keep it there—potentially for the child's lifetime.
You can contribute up to $5,500 a year to an IRA, but not more than the amount of your taxable income. So your child could fund a kiddie Roth IRA with pay earned as a camp counselor, say, or by busing tables. Most kids will not have the ability or discipline to fund the account through their earnings. But adults can reward their hard work by contributing on their behalf. This demonstrates the value of saving and gives kids a first-hand look at how a real 401(k) works—and may encourage Gen Z to eventually take full advantage of the savings plan at their first job.
The kiddie Roth also gives young savers those critical extra years of compound growth. An early starter who saves the maximum Roth IRA contribution each year from age 15 to 70 would end up with double the retirement account balance of a worker who saves the maximum beginning at age 25, Fidelity estimates. In other words, your child at age 70 could end up with $1 million instead of $500,000 just by getting this head start.
The additional saving is all the more important for young people, who will have fewer sources of guaranteed lifetime income in their retirement years. Increasingly, parents who may have seen their own savings fall short, and their pension guarantees erode, are moving proactively to get kids started now.
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The Roth IRA also allows for penalty-free early withdrawals for an initial home purchase or college tuition, a provision that leads some financial planners to regard the Roth as a complement or substitute for popular 529 college savings accounts.
Fidelity says it decided to launch its kiddie Roth after “monitoring demand” and deciding now “was a good time to move forward.” Schwab has offered such a custodial account for years. Fidelity’s entry suggests the market has become big enough to accommodate more players and that this may be the next battlefield for Wall Street to gather assets. That's fine, if the result is a more secure retirement for the future generations.