Traditional IRAs (for Parents)
A traditional IRA allows your Teenvestor to make annual tax-deductible contributions. The contributions to the account are tax deferred until he reaches age 59½, at which point he can withdraw the money and get taxed at his tax rate at the time of the withdrawal. His tax rate at age 59½ or later will probably be much lower than his tax rate during his working years. Your Teenvestor can buy stocks, bonds, and other assets with the money in the account just like a regular non-IRA custodial account or a Roth IRA (see Roth IRAs another section in this site).
As with Roth IRAs, your Teenvestor may only invest in a traditional IRA if he has earned income. This means the traditional IRA raises the same “earned income” questions as discussed in the previous section concerning Roth IRAs. Traditional IRAs are also subject to the same contribution thresholds as Roth IRAs (namely, taxable compensation up to $5,500 per year), and are set up the same way as Roth IRAs.
Drawbacks to Traditional IRAs
There are two significant drawbacks to traditional IRAs. First, upon retirement, withdrawals from the IRA are taxed. As discussed above, with a Roth IRA, once the investor has reached age 59½, withdrawals from the account are tax-free. Second, contributions to traditional IRAs can’t be withdrawn before age 59½ without a 10% penalty in addition to the payment of regular income taxes.
There are a limited number of exceptions to this rule, including withdrawals for paying qualified education expenses. By contrast, the Roth IRA permits withdrawal of original contributions prior to 59½ for any reason (after five years). For these reasons, many investment experts believe the Roth IRA is superior to a traditional IRA, especially for young people with very little or no earned income.