Should Doctors Open Roth IRAs for Their Kids?

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Many doctors prioritize their financial health and seek to pass that trait onto their children.

Plus, given the current state of financial literacy in the U.S., most education about money and personal finance falls on parents or caretakers. And one of the most important financial concepts to teach is the art of compounding interest—something you can tap into via long-term investing.

How can doctors introduce their kids to this idea?

Give them a vehicle to invest in their future.

One account that could fit the bill is a Roth IRA. These unique and advantageous accounts could help set your child up for success. 

Here’s what doctors should know about opening a Roth IRA for their kids.

Why Consider A Roth IRA for Your Kids?

Roth IRAs come with several benefits for adults and children alike, and they’re certainly head and shoulders above a traditional piggy bank. 

For starters, kids have so many years for the funds to compound and grow tax-free. More time means more compounding potential, which could result in exponentially more funds further down the road.

Roth IRAs also offer immense flexibility because your kids can withdraw contributions (not earnings) tax and penalty-free, giving them access to the money should they need it. 

Furthermore, Roth IRAs can grow with your kids as they work to achieve certain financial and personal milestones. For example, your kids can take out funds (contributions and earnings) from a Roth IRA penalty-free for qualified education expenses, up to $10,000 to buy their first home, $5,000 for the birth or adoption of a child, etc. But keep in mind that they will likely have to pay income tax on those distributions.

And the benefits just keep on coming! 

Roth IRAs have incredible tax benefits, especially for children and young adults. You fund Roths with after-tax dollars, and since most kids aren’t raking in millions, they won’t have to worry about the fact that there’s no tax break for contributions.

Roth IRAs also allow your kids to get a jump start on retirement. While that event may seem light-years away, it’s important to teach your kids that it’s never too early to save for the future. By investing in a Roth IRA, they will start to learn what investing for something “long-term” really means.

The Rules That Come Along For The Ride

While there are numerous benefits to opening a Roth IRA for your kids, there are a few rules you’ll need to abide by. 

First, to open a Roth IRA, your kids must earn reportable income—whether they work part-time for you or have a summer job dog walking or babysitting. They can contribute funds as long as they earn income in the year they contribute.

You may ask, can you contribute for them? 

Yes, but they still have to earn an income, and any contributions (yours or theirs) can’t exceed what they’ve made in a year. So if they bring in $1,000 from babysitting, you can only match $1,000 of earned income. It’s also important to be mindful of the gift tax in this situation. 

The contribution limits remain the same for all people who contribute to an IRA. For the 2022 tax year, contributions cannot exceed $6,000 (or $7,000 if 50 or older).

Let’s do some quick math. If your kid can max out earnings to fully fund a Roth IRA each year starting at age 8, and we estimate a 5% compounding rate of return annually (which is subject to risk and volatility), you could be giving them just over $129k in a Roth IRA when they finish college at 22. 

That’s a really nice start for the future!

How Can You Open A Custodial Roth IRA?

Your child’s income makes them eligible for a Roth IRA, but a parent or guardian will have to open the account for them. Many major financial institutions like Fidelity, Vanguard, and Schwab allow parents to open custodial Roth IRAs on behalf of a minor. The process is pretty quick and painless and will probably take less than 30 minutes!

However, keep in mind that even though you “control” the account until they reach the age of majority, the money technically belongs to your child. Once they reach the majority age, they can use the money as they see fit—invest, withdraw, or go on a lavish vacation. 

Direct access to this money is a lot of responsibility, so it’s necessary to communicate with your children and openly have discussions regarding money and personal finance.

A Roth IRA In Action: A Case Study

Years ago, we worked with a practice owner who often used family pictures as advertisements. His accountant was comfortable compensating the children for “modeling” in their father’s practice ads. After the accountant gave us the green light, we could pay his kids enough wages to max out a Roth IRA for each child every year. 

Remember, you must have a mechanism to pay real reportable wages to the children for them to be eligible to contribute to a Roth IRA, and business or practice income is one of the best ways to do this. Talk with your accountant and advisor to help you devise a strategy. 

Is A Roth IRA Right For Your Kids? The Verdict Is…Talk With Your Advisor.

There are numerous benefits to opening a Roth IRA for your children, but it all comes down to what is best for you and your family. 

If you have questions about opening a Roth IRA for your children, get in touch with our team at Vestia.

Disclaimer:

Investment advisory services offered through Vestia Personal Wealth Advisors, Vestia Retirement Plan Consultants, and Vestia Advisors, LLC. Securities offered through Ausdal Financial Partners, Inc., 5187 Utica Ridge Rd, Davenport, IA. 52807 (563)326-2064. Member FINRA/SIPC. Vestia Personal Wealth Advisors, Vestia Retirement Plan Consultants, Vestia Advisors, LLC, and Ausdal Financial Partners, Inc. are independently owned and operated.

This material is intended for informational purposes only. It should not be construed as legal or tax advice and is not intended to replace the advice of a qualified attorney or tax advisor.  This information is not an offer or a solicitation to buy or sell securities.  The information contained may have been compiled from third-party sources and is believed to be reliable.

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