How can my 6 year old max out in a Roth IRA?

[Guest Ted T]

How can my 6 year old max out in a Roth IRA? Does he have to show earned income? Are there ways to get around that?

[John G]

IRAs for children has come up before, see these reference:

http://benefitslink.com/boards/index.php?showtopic=9284

http://benefitslink.com/boards/index.php?showtopic=8885

http://benefitslink.com/boards/index.php?showtopic=7683

http://benefitslink.com/boards/index.php?showtopic=7656

Another short citation on children and Roths

http://detnews.com/2000/business/0007/04/b10-85589.htm

From my prior posts:

Your child MUST have earned income to qualify. Dividends, interest, gifts and capital gains do not count.

It is unlikely that a very young child would have a paper route or babysit or be able to effectively contribute to a family business unless you pay someone $2000 to take out the garbage. I know an attorney that uses his infant son in an advertisement and pays a modeling fee... but that is a rare arrangement. If none of these situations seem to apply, then just wait a few years. My kids were mowing lawns and delivering papers at age 12. Age 6 is not impossible but highly unlikely. Do NOT open an IRA if you can not document the earned income of the minor.

If you have a credable earned income, then you need to think about two things on the front end: who is my custodian, and what type of investments am I likely to make. Custodians can include banks, brokerages, mutual fund families, etc. Many of the brokerages such as Schwab and Etrade give a chance to buy stocks, bonds and mutual funds. You can move a Roth account, so initial choices do not bind you forever. NOTE: Etrade will not accept IRAs for minors, but Charles Schwab does. So, you need to ask a few potential custodians if the age 17 is a problem.

Lots of folks have no problem dealing with out of town firms, especially now that they almost all have outstanding web sites. Banks used to have fairly conservative choices but are starting to offer more options. Banks are ussually local and you may value face-to-face service. But don't expect to call a bank employee using an 800 number at 11pm, and many have poor internet options. You may want to read the March issue of Consumer Reports or subscribe to Kiplinger Personal Finance mag. Both a good sources for beginners.

Ask about fees. There are many firms that do not charge any annual fees for IRA accounts. Others charge $10-20 per fund or per account. Some eliminate the charges if you just ask, or when your assets grow. The brokerage commission fees for trades range from ultra low to high. Same with the imbedded expense rates for mutual funds. Since there are perhaps 8,000 stocks and another 8,000 mutual funds it is impossible to generalize. The nice thing about Consumer Reports is that the boil down the mutual fund choices to a hundred or so good ones and explain things in laymen terms.

My suggestion for beginners: invest in a growing future by putting your IRA funds into a general stock mutual fund and a very good version of these is a broad based index fund like on that mirrors the S&P500. Why? Easy to track, easy recordkeeping, market performance, diversification and low cost/expense. After 4-5 years of contributing and letting this account grow you may want to split your assets between a couple of funds. Later still, when you pass the 100k mark you may feel comfortable with owning 8 to 12 individual stocks.

Equities (aka stocks) are an investment in growth. Sure, stock markets go up and down. But good years out number bad years by anywhere from 5:1 to 8:1 and over many decades equity investments will do a better job (much better than CDs) of growing above the general rate of inflation.

[John G]

I don't want to appear overly negative by the above comments. If a child has earned income, then a Roth IRA is an excellant idea since the assets are sheltered longer. For example, starting a Roth for a child at age 6 versus age 20 creates two extra doubling periods using 10% and the "Rule of 72". So, 1M in assets accumulated in a Roth started at age 20 (which is a common IRA example) could be over 4M in asset with the early start.

Funding a childs Roth IRA for 14 years (age 6 to 20) at the maximum involves transfering 28,000 but would create a very significant tax free estate for the offspring... which could readily grow to over $2M by the time the son/daughter was ready to retire.

Note, a rebellious child would have access to the IRA after they turn either 18 or 21 depending upon the state of residence.