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College and Adulthood Planning – Traditional IRA or Minor Roth IRA

As a retirement savings vehicle, almost everyone has at least one IRA. And the Roth IRA has become a very popular option when it comes to planning for your children’s future. Let’s take a closer look at how to use these products to the best advantage for college and adulthood planning for your kids.

We’re looking at Traditional IRAs and Minor (or Custodial) Roth IRAs as part of a series of articles to help you plan for your children’s education and/or other paths they choose as they enter adulthood. For an overview of the series, click HERE.

Traditional and Roth IRAs are so popular because they offer several benefits not just when it comes to saving for retirement, but educational expenses too. Let’s take a look at both and see which, if either, might be right for you to leverage on behalf of your children’s future.

Traditional IRA

We all know about early withdrawal penalties when it comes to IRAs, but many people do not know about the qualified educational expenses that are exempt from those penalties. These would include regular tuition, fees, books, and supplies required for enrollment. Room and board are also covered for students who are enrolled at least half-time. You cannot use an IRA to pay off student loans after graduation but you can use them to offset loan payments while the child is still in school.

You will need to show that the student is attending an eligible, accredited institution of higher learning, like a college, university, or vocational school. It can be public, private, or non-profit. Any post-secondary school eligible for student aid programs via the U.S. Department of Education should qualify, but you will want to verify this before making a withdrawal.

Minor Roth IRA

Another way to go is with a Minor (Custodial) Roth IRA. You can open one for a child of any age, as long as they have some kind of earned income. If you own a business, you can pay a child directly into a Roth, or they can make contributions into the Roth from their earnings. Let’s hone in on these factors and dig into them a bit more.

  • Really? No age limit? That’s right, opening a Roth account is about income, not age. So, as long as a child has a source of income, you can open a custodial account for them.
  • What counts as earned income? Earned income is defined by the IRS as taxable income and wages. This would include money earned from a W-2 job or typical self-employment like lawn mowing or babysitting. Again, if you have a business, you can hire your child and pay them. You can also make contributions to their account, as long as the amount does not go above the income they earn in a given year.
  • What are the contribution limits? The Roth IRA contribution limit is $6,000 a year in 2020, or the total of earned income for the year, whichever is less. If a child earns $2,000 babysitting in 2020, he or she can contribute up to $2,000 to a Roth IRA. With a Roth IRA, after-tax contributions can be withdrawn and used for any purpose (unlike with a Traditional IRA where the money can only be used for qualified educational expenses.) Your original contributions can be withdrawn tax-free, but the earnings from your investments will be counted as taxable income if you’re under 59 1/2. However, if your Roth IRA has been funded for five years, your child can take out up to $10,000 in earnings to buy a first home, tax- and penalty-free.

Especially if you own a business, or if your child is always looking for a way to earn money, the Minor Roth IRA might be a great option. If you have a Traditional IRA and your child is definitely headed for college, that money can be used for educational purposes without penalty. If you want more flexibility, you can also convert all or a portion from a Traditional IRA into a Roth IRA.

If you have any questions about IRAs or planning for your children’s future in general, we would love to talk with you!