Opening a Custodial IRA for a Minor

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

Are ETFs a Good Way to Create Secondary Streams of Income?

ETFs, or Exchange Traded Funds, are all the rage in the investment world, but so far, they really don’t have much of a track record. This is a fairly new method for investing and the long term data just isn’t there to determine how effective these investments can be over time.

There is a lot of controversy over whether or not ETFs are sound, but many of them do produce impressive gains over the short term. So, are these investments a good way to create a secondary stream of income? Let’s take a look at the benefits and downsides of this form of investment.

Risk –

This will depend largely on the type of ETF you select. For example, those that sunk their money into housing or mortgage funds are truly regretting that decision now and facing catastrophic losses. Those that stuck with a more diversified fund, like the SPDR Trust, or the Vanguard Total Stock Market Vipers are in a better position.

The key is picking the right kind of ETF. Right now, until there is more data available on these funds, it is best to stick with the ones that are well known and diversified. These funds do have a short term track record of performing well, and there is much less risk than with a “designer” ETF.

Short Term Gains –

ETFs can do very well in the short term, with some returns in excess of 30% over six months. However, look at the long picture, and that may drop to -30% for twelve months. The bottom line is that this is not a reliable long term investment. There is just too much room for risk and losses can be high when you look at the data for many of these funds.

Some people have found that getting in and out with an ETF is the best strategy, but ultimately, that decision is up to you and your broker. Many of the benefits of an ETF are outweighed by the inherent risks and the overall lack of good performance data.

So, what does that spell for those looking to create multiple streams of income? Right now, unless you are willing to ride out the markets, the answer is probably now. So far, the data indicates that ETFs are solid performers short term, and not so reliable over the long term. Whether you want to take that risk of sinking your money in and hoping for long term gains is completely up to you. However, there are many other long-term performers out there that are much more suited towards building a reliable secondary stream of income.

Diversity is always good however, and if you have some extra money that you are not relying on, you may want to discuss ETFs with your broker. One thing is certain, these funds will be interesting to watch, especially over the next two years as the housing market and the state of the economy continue to affect them.

source:  richcreditdebtloan.com