By Joe Cicchinelli, IRA Technical Expert
Follow Me on Twitter: @JoeCiccEdSlott
Now that we are in the middle of the summer of 2013, have you ever thought about contributing to an IRA for your child or grandchild this year? It’s possible as long as certain rules are followed.
The first rule is that the child must have compensation or earnings from a bona fide job to make an IRA contribution for the year. Some children have summer jobs, either full-time or part-time. Even if the child spent all of his or her summer job money, an IRA contribution can still be made for them. The source of the funds used to make the IRA contribution doesn’t matter, so you, the parent, can make the contribution for your child using your money. Also, there’s no rule that prohibits a minor from having an IRA.
The second rule is that there is a limit on how much can be contributed. The maximum IRA contribution for 2013 is $5,500. However, if the child earned less than that, the maximum IRA contribution would be limited to the child’s earnings. For example, if your granddaughter earned $2,900 working at a summer job, the maximum IRA contribution that could be made for her is $2,900.
Starting an IRA for a child can be a great way to save, especially when you factor in the power of compounding interest. When interest is added to principal, from that moment on, the interest that has been added also earns interest. This is called compounding, and makes the account grow larger over time. But even better, IRAs have an advantage that regular bank accounts don’t; no taxes are due each year on the interest earned inside an IRA.
You should consider making a Roth IRA contribution for your child instead of a Traditional IRA contribution. Roth IRA distributions are generally tax-free whereas distributions from Traditional IRAs will be taxable.
Starting an IRA for a child that has compensation is a great way to save. The earlier you start the better.