Regular readers know that that I LOVE Roth IRAs and Roth 401(k)s. The opportunity to save money for retirement into a bucket where it grows without tax and can be removed without tax is FABULOUS.
So, you and your spouse each max out a Roth IRA each year ($6,000 plus $1,000 catch up for those better than 50 years old) and max out your Roth 401(k) deferral ($19,500 plus $6,500 catch up for those better than 50 years old), but what about the kids?
Can your kids have a Roth IRA?
Would that be a good idea?
The answer is, SURE. It’s a great idea.
There is no age restriction on a Roth IRA. There are, a few details:
- People under 18 must have a custodian (a legal adult) open the account on their behalf. The account is registered to the minor, but he adult signs the paperwork an is accountable.
- Your kids would need to show income.
- Work as a babysitter, cutting grass and odd jobs is fine.
- Minors can save the first $6,000 of income into the Roth IRA.
- Minor children earning less than $12,400 in 2021 would NOT need to file a tax return.
- All deposits can be removed at any time, for any reason, with no tax consequence.
- When the Roth IRA is at least 5 years old, distributions of the growth in the account will not trigger a penalty. The distribution is still taxed as income, but not with the 10% penalty.
- Buy or build a first home up to $10,000
- Qualified higher education expenses.
Don’t forget why I LOVE the Roth IRA.
A Roth IRA gives NO tax deduction for deposits. But the account grows free from tax and distributions after age 59.5 are all free from income tax. So, how does this compare to other options?
- Taxable brokerage accounts report income each year for interest and dividends received. Sales of investments at a profit show as capital gains in the year of the sale.
- Traditional IRAs offer tax deduction in the year of deposit. The account grows without tax AND all distributions are taxed as income in the year of the distribution.
Comparing Roth IRAs to Traditional IRAs.
- If your income tax rate is the same in the year you make deposits and the year you make distributions, the NET SPENDABLE MONEY from each account is the same.
- If you DO NOT think tax rates in retirement will be the same as now, then:
- Favor a Traditional IRA if you believe YOUR income tax rate will be lower in retirement.
- Favor a ROTH IRA if you believe YOUR income tax rate will be higher in retirement.
- Which IRA is best for you depends on what you believe your retirement looks like:
- Will you spend more or less money when you are retired?
- Smaller house.
- Less travel.
- Less dinners out.
- Older car.
- Less health care.
- Will income tax RATES rise or fall in retirement?
- Will your cash flow come from pensions and Social Security, or retirement distributions?
- If you have regular pension checks, you can set your withholding to pay the income tax due, otherwise you will need to make quarterly tax payments.
- If you make quarterly tax payments, you may need to make retirement distributions to cover those payments. For most of my retired clients, the IDEA of taking out $14,000 to spend $10,000 just makes them crazy.
- Remember the big picture:
- Income tax rates are historically low today.
- In 1945 the top income tax rate was 94% for income over $200,000 ($1.84M in 2020 money).
- Today, the max tax rate is 37% for income more than $622,050 per couple.
- Federal debt is at a historical high.
- Income tax rates are historically low today.
- Will you spend more or less money when you are retired?
- In 1970 the debt was about 40% of Gross Domestic Product, today it’s almost 140%.
Each of these two facts suggest, that the U.S. government MIGHT raise taxes in the next 15 to 30 years. So, if you are in your 60s or younger, I would suggest you can expect to see higher income tax rates again in your lifetime.
If I am right that income taxes are likely to be higher during your retirement, that favors a Roth IRA.
If you have questions about how a Roth IRA fits into your personal retirement plan, a great place to start looking for the right advisor is to talk with a couple CERTIFIED FINANCIAL PLANNER™ professionals.
To find a CFP® professional near you, start your search here.
As you visit with financial planners, I suggest a couple things to check:
- Is the advisor always the client’s advocate – a fiduciary advisor?
- Is the advisor only paid by clients, not any financial product manufacturer or distribution network? That would be a fee-only advisor.
These two points help assure that you are working with a professional who is committed to your best interest at all times. It seems sort of obvious to me that a professional would work in this way, but it’s not automatic.
A fiduciary, fee-only, CFP® professional can help you make great retirement income choices and develop a comprehensive financial plan that is driven by your goals and priorities and addresses all aspects of your financial life. With a big-picture approach, you will be better prepared to understand your options at every step along the way.
Yes, I am a CFP® professional. I’m always a fiduciary and I only work on a fee basis. And yes, I’m still taking on a few great families to be part of my financial planning practice.
Follow this link to find a time for us to talk more about your situation.
If this article has you thinking about your own circumstances, contact my office at rdunn@dunncreekadvisors.com. I am always happy to meet with people who are working on their retirement plans. Dunncreek Advisors does not provide legal or tax advice, nor is this article intended to do so.