If you’ve been through the public (or even private) school system, you know well that personal finance is not taught in school, unfortunately.
If you have children and you read personal finance blogs, you also know that amongst the most valuable skills you can teach/learn in life include personal finance, delayed gratification, and the power of compound interest. Right? (that was a hypothetical)
They won’t learn the true power of compound interest by sticking their savings into a bank account these days, with interest rates being as miniscule as they are. And you can’t add their savings to your own investment accounts, without tax implications.
So where can one turn?
A custodial IRA!
Today, we’ll discuss IRA’s for minors – otherwise known as custodial IRA’s, how they work, and when they can be contributed to.
I thought it would be easiest to go through a list of questions I had about custodial IRA’s and the answers I found.
What is a Custodial IRA?
At its simplest, a custodial IRA is an IRA for a minor with earned income. The IRA is opened in the name of the minor (under their Social Security number), but is managed managed by custodian (usually a parent, grandparent, or legal guardian), generally until the minor reaches age 18 or 21 (varies by state rules). At that point, control over the custodial IRA is assumed by the minor, and the “custodial” tag is removed.A custodian cannot withdraw or remove funds from an account they are managing, for any reason. It is owned by the minor.
How do Custodial IRA’s Differ from Regular IRA’s?
Really not at all other than the whole custodial thing. You can open either a Roth or Traditional custodial IRA.The maximum IRA contribution is still the same ($5,000 for 2012 and $5,500 for 2013) for both a Traditional IRA or Roth IRA, up to their earned income (which we’ll get to in a bit).
And all the tax, penalty, and early withdrawal rules are the same.
The only other differences you may come across is different rules (i.e. opening account minimum) or fees from the various IRA administrators out there.
When Can a Minor Begin Contributing to an IRA?
Here’s the tricky part – contributions may not exceed the minors earned income for the year. That doesn’t mean that the contributions have to come directly from that earned income, just that the total contributed cannot exceed what they earn for that tax year.The IRS defines “earned income” as wages, commissions, tips, salaries and self-employment income. So a minor could be a self-employed driveway shoveler at age 7, for example, and it could be considered earned income. Allowances for your household chores are generally not accepted to be earned income by the IRS.
If the child receives Forms W-2 or 1099, you automatically have records of earned income. Otherwise, keep detailed records of how much money was earned when and from whom.
Investment and inheritance income is not considered to be earned income.
source: 20somethingfinance.com
