Roth IRAs (for Parents)
The Roth IRA has been increasingly popular since its enactment into law in 1997. An investor can make annual contributions with after-tax dollars to a Roth IRA account and accumulate earnings until age 59½, at which time he can withdraw the money tax-free. Your Teenvestor can establish a Roth IRA and buy stocks, bonds, and other assets for the account just like for a regular, non-IRA custodial account.
Original contributions to a Roth IRA, as opposed to accumulated earnings (loosely coined, the profits generated by the account), can be withdrawn tax-free prior to age 59½ without a penalty, after five years. If, however, your Teenvestor withdraws all his contributions, then proceeds to withdraw the accumulated earnings in the portfolio before turning 59½, he will not only pay taxes on the earnings but will also pay a 10% penalty. There are limited exceptions to this rule, including withdrawals for paying qualified education expenses.
A Roth IRA, like any other IRA, can be set up through a bank or stockbroker. Many brokerage firms will open custodial IRAs for children. However, fees and minimum balances vary, so it is necessary to shop around. To qualify as a Roth IRA, the account must be specifically designated as such. Contributions to the account must be made in the form of money (cash, check or money order), and that money can then be used to buy stocks, mutual funds, and other assets for the account.
While a Teenvestor can have more than one type of IRA in addition to the Roth IRA, such as a traditional IRA and a Coverdell Educational Savings Account (described below), his combined contributions to a Roth and traditional IRA can’t exceed the lesser of his total yearly wages or $5,500. This means that if your Teenvestor’s taxable compensation is less than $5,500, he may only contribute as much as he earns.
If he earns more than $5,500 per year, the maximum he can contribute each year is $5,500. Teenvestors can’t contribute to their IRA in years in which they have no earned income. On the other hand, once the IRA is established, it is not necessary to contribute to it for every year in which income is earned. Account holders are not permitted to contribute more than the amount allowable for the year to "make-up" for years in which little or no contribution was made.
Anyone who works and thus receives earned income, or more specifically, taxable compensation (defined to include wages, salaries, tips, and amounts received for providing personal services), during the year can establish a Roth IRA.
Both Roth and traditional IRAs (discussed in another section of this site) have income limitations, which restrict higher wage earners from investing in them. It’s unlikely that your Teenvestor needs to be concerned with these limitations, because his earned income would probably not reach the income limitations. However, if you are concerned that your Teenvestor may be subject to these thresholds, we recommend that you consult IRS Publication 590-A (Contributions to Individual Retirement Arrangements) and a tax or investment consultant for more information.