Roth IRAs and Family: What You Need to Know

If you have a Roth individual retirement account (IRA), you probably already know that it’s a great way to save for your later years. But if you want to help a loved one kick-start their retirement fund, can you open a Roth IRA for someone else? You can, and here’s how.

Open a Custodial Roth IRA

There are several ways that you can gift a Roth IRA. One is opening a custodial account for a minor. Let’s say you’re a parent or grandparent who wants to help kids secure their financial futures. Instead of just telling them about Roth IRAs (although that’s fine, too), you could start one for them in their name.

Since they’re minors, it has to be a custodial account. An increasing number of brokerages offer these Roth IRAs for kids. Some firms even waive or reduce their usual account minimums to set one up.

A Roth IRA can help a child save not only for retirement but also for college or a first home. Opening a Roth may even encourage the child to get a job or start a little side business so they can add money to the account.

Once the child is no longer a minor, you can still give them money each year to help fund their Roth accounts, as long as they meet the earned income and other requirements.

Earned Income Requirements for Roth IRAs

One potential hitch in funding a Roth IRA for a minor child is that the account owner (in this case, the child) must have taxable compensation during the year for which the contribution is made.

Taxable compensation, sometimes referred to as earned income, includes wages, salaries, commissions, and income from self-employment. Investment income, like interest and dividends, doesn’t count.

The income can come from part-time jobs like babysitting or working at the grocery store. Odd jobs are fine, too, but the wages have to be reasonable. Are you OK with $25 to weed the garden? Sure. But you probably can’t get away with paying your grandkids $1,000 to mow the lawn or wash the car.

Contribution Limits for Roth IRAs

Here’s another consideration: The contribution is limited by the amount of the account holder’s earned income. If your grandson earned $2,500 working during the year, he (and you) can only contribute that much, even though the overall contribution limit is $6,500 for 2023 and $7,000 for 2024.

Still, there’s no stipulation in the Internal Revenue Service (IRS) guidelines that says the $2,500 that he invests in the Roth IRA has to come directly from his earnings. He can earn $2,500 and spend it on a mountain bike and car insurance if he so desires. This means that you can give him a gift of $2,500 to put into the Roth IRA. Just make sure that the amount you give (and he deposits) doesn’t exceed what he earned. In fact, if you match or partly match what he earns, it’s a good way to introduce him to the concept of matching funds.

Name Them As Your Beneficiary

Another way to gift a Roth IRA to someone is to make them the beneficiary of your account upon your death. You do this simply by designating them as such on the Roth IRA forms that you fill out for the financial institution that holds the account. A spouse is the usual choice, but anyone of any age can be a beneficiary or co-beneficiary.

Leaving a Roth IRA to one’s heirs is an increasingly popular tool in estate planning. One reason is that Roth accounts don’t have required minimum distributions (RMDs) during the original owner’s lifetime. This means that if you don’t need the money, you can keep it in the account to continue growing and leave it to your beneficiaries intact.

Another reason why Roths are popular for estate planning is that assets with a designated beneficiary, such as retirement accounts, don’t have to go through probate, as bequests from a will do. The Roth passes directly to the beneficiary, which can save a lot of time and money.

A spouse who is a sole beneficiary can elect a spousal transfer and treat the IRA as if it were their own. Children or other non-spousal beneficiaries who inherit a Roth eventually must withdraw the money, typically by the end of 10 years. But they won’t owe income tax on it, provided that the Roth was at least five years old at the time of the original owner’s death.

Either way, you can set up a loved one with years of tax-free growth and income by leaving them your Roth IRA.

Offer Them a Financial Education

You don’t have to actually hand a wad of cash to someone to give the gift of a Roth IRA. Instead, you can share with them everything they could ever want to know about Roth accounts and IRAs in general, such as:

• Whether they can contribute based on their income
• How even small contributions to tax-advantaged accounts can build up over time
• How Roth IRA taxes work

Simply sitting down with them and going over the massive potential benefits of opening and regularly funding a Roth IRA could be a huge gift.

You may not be able to afford to help fund the account for them—or they may not yet meet the qualifications. That’s fine. Igniting the flame of curiosity is a great start.

Frequently Asked Questions

The Bottom Line

A Roth IRA may not be the most exciting gift out there. But it’s one that your loved ones will benefit from for years or decades to come. And that makes a Roth IRA a gift that truly keeps on giving.