My kids started earning money during the pandemic, and we found the perfect account to let their cash grow tax-free (2024)

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• My kids started earning money while stuck at home during the pandemic.
• Instead of keeping their cash in a savings account, I'm using a custodial Roth IRA to invest it.
• Thanks to compound interest, their money can earn thousands — tax-free — over the next 60 years.

During the pandemic, my 3- and 5-year-old sons started earning money while being bound to our neighborhood. Between an Instagram ad here and a socially-distanced lemonade stand there, they've each brought in around $600 of earned income.

At first, I put their money into a high-yield savings account. But after investigating the other options available for their earned funds, I discovered the holy grail of children's accounts: the custodial Roth IRA.

What is a custodial Roth IRA?

The custodial/minor/child Roth IRA has the same setup as an adult Roth IRA, a tax-advantaged retirement account, except it's managed by an adult (does not have to be a parent) on behalf of the minor until they are older. The age it transfers to the child varies by state. It is subject to the earned income limits of $6,000 or the total amount made in a year, whichever is lower. For example, if a child makes $1,000 from babysitting, that is the maximum an adult can contribute that tax year.

Earned income cannot include birthday money or gifts, but can consist of non-W2 work such as babysitting, snow shoveling, and dog walking. And perhaps most importantly, it is a goldmine for teaching children about compound interest.

According to Investor.gov, starting my children's Roth now and contributing $50 a month could lead to a tax-free pot of money of over $357,000 in 60 years, 90% of which would be growth even if the contributions never increase (based on 6% growth compounded monthly).

Why I chose a Roth IRA for my kids over other accounts

There are drawbacks when comparing a custodial Roth IRA to other investment options for children. Mostly, they cannot access the earnings without a penalty until age 59 1/2. They also have full control and could withdraw everything, unlike a 529 account, which the beneficiary uses for eligible education expenses. However, the custodial Roth IRA advantages far outweigh the limitations for our family.

The top upside to the minor Roth IRA is that it continues to grow tax-free. The idea of 60 years of tax-free growth should send a shiver down anyone's spine.

The minor Roth IRA is also more flexible than it initially appears. First of all, like other retirement accounts, the money in a custodial Roth IRA will not affect access to student aid as it's not reported on the Free Application for Federal Student Aid. Second, the beneficiary can withdraw up to $10,000 penalty- and tax-free for their first home. And, like adult Roth IRAs, the original contributions can always be pulled out of a custodial Roth IRA without penalty.

How to set up a custodial Roth IRA

Setting up a Roth IRA for children is simple. My husband and I went with Fidelity due to our familiarity with the platform, but a few other providers offer them as well, such as Charles Schwab. You need a checking or savings account in the minor's name that feeds into their minor Roth IRA with the matching name. We opened minor savings accounts for each boy used exclusively to fund their custodial Roths.

While parents often hear about 529s, UTMAs, and other investment vehicles for children, the custodial Roth IRA should be on your list to explore. That $2 cup of lemonade your child sells starts to look a lot sweeter with 60 years of tax-free investment growth served alongside it.