Custodial Roth IRA: how a Roth IRA for a child works, who qualifies, and the tax rules

A custodial Roth IRA is an ordinary Roth IRA owned by a minor and managed by an adult custodian, usually a parent, until the child reaches the age set by state law. The IRS imposes no minimum age, but the child must have earned income, and the year's contribution cannot exceed the lesser of that earned income or the annual IRS limit. The money contributed does not have to be the child's own; a parent can fund the account as long as the child earned at least that much.

The appeal is arithmetic. A child typically pays little or no income tax, so a Roth contribution costs almost nothing in forgone deductions, and the balance then has forty or fifty years to grow tax-free. The constraints are the earned income test, the record-keeping it demands, and the fact that the account belongs to the child, not to you. This guide covers each in turn.

What a custodial Roth IRA is

Legally the account is the child's. The custodian opens it, signs the paperwork, chooses the investments and handles contributions and withdrawals, but acts as a fiduciary for the child and cannot use the money for their own purposes. When the child reaches the age of majority under the state's custodial account law, the custodian's authority ends and the account converts to a regular Roth IRA in the child's sole control.

It is worth distinguishing it from a UTMA or UGMA custodial brokerage account. Those hold any assets, need no earned income, and are taxed each year under the kiddie tax rules. A custodial Roth IRA requires earned income, holds retirement money, and is never taxed on its internal growth. The two can work together: a child with wages can hold both.

The earned income requirement

The IRS uses the word "compensation" in Publication 590-A. For a child the relevant items are:

• Wages, salaries and tips reported on a Form W-2, including part-time and summer jobs.
• Net earnings from self-employment, such as babysitting, lawn care, tutoring or selling things online, after subtracting the deductible part of self-employment tax.
• Taxable scholarship or fellowship income in some cases, where it is reported as compensation.

What does not count: allowances, cash gifts, interest, dividends, capital gains, and investment income of any kind. The IRS describes these as earnings from property rather than from personal services. A child who received $5,000 in dividends from a UTMA account but earned nothing has no room to contribute.

Self-employment income counts only if it is real and reported. A child who earns $1,500 babysitting must report that income on a return, and if it exceeds the self-employment tax threshold, pay self-employment tax on it. There is no mechanism to count informal cash earnings that were never declared. Keep a simple log of dates, clients, work done and amounts, and keep bank or payment-app records where they exist.

How much can be contributed

The cap each year is the lesser of two figures: the child's compensation for the year, or the annual IRA contribution limit, which the IRS adjusts periodically. A child who earns $2,400 can have at most $2,400 contributed. A child who earns more than the annual limit is capped at the limit.

Two points often surprise parents. First, the source of the contribution does not matter. The child can spend their wages and the parent can contribute an equal amount. The IRS tests how much the child earned, not whose dollars were deposited. The parent's contribution is a gift to the child for gift tax purposes, which is rarely a problem within the annual gift exclusion. Second, Roth contributions are also subject to income phase-outs, but these apply to the child's own modified adjusted gross income, not the parents'. For almost every minor that is irrelevant.

Contributions for a tax year can be made up to the filing deadline for that year, generally mid-April of the following year, which gives time to total the year's earnings before deciding the amount.

Paying a child through a family business

Many custodial Roth IRAs are funded by wages from a parent's business. This is legitimate when done properly and is treated favourably by the tax code, but the conditions matter.

• The work must be real and the wage reasonable for the task and the child's age. Filing, cleaning, stocking shelves, basic bookkeeping, website work and modelling for product photographs have all been accepted. Paying a seven-year-old a salary for "consulting" invites challenge.
• Document it like any employee. A written job description, timesheets, payment through payroll and a Form W-2 at year end. Pay by cheque or transfer into an account in the child's name.
• The payroll tax treatment depends on the business structure. The IRS states that a child under 18 employed by a parent's sole proprietorship, or by a partnership in which every partner is a parent of the child, is exempt from Social Security and Medicare taxes, and that a child under 21 in those businesses is exempt from federal unemployment tax. Income tax withholding rules still apply. If the business is a corporation, or a partnership that includes a non-parent partner, all payroll taxes apply regardless of the child's age.
• The wage is a deductible business expense. The business deducts it at the parent's marginal rate, and the child reports it at theirs.

A dependent child's standard deduction covers earned income up to the regular standard deduction amount, so a child with modest wages and little investment income typically owes no federal income tax at all. The wage has moved from the parent's return, where it would have been taxed, to the child's, where it often is not, and then into a Roth IRA where it will never be taxed again. That is why this arrangement draws scrutiny, and why the documentation is not optional.

Why Roth rather than traditional for a child

A traditional IRA gives a deduction now and taxes withdrawals later. For a child in a 0% or 10% bracket the deduction is worth almost nothing, while the future tax on decades of growth could be substantial. The Roth reverses that: no deduction today, when the child would not have used one, and no tax ever on qualified withdrawals. For almost every minor the Roth is the only sensible choice, which is why the traditional version is rarely used for children.

An illustration, clearly labelled

Suppose a child earns at least $3,000 a year from age 15 to 19 and a parent contributes $3,000 to the custodial Roth IRA at the end of each of those five years, then nothing further. Assume a 6% annual return, before fees and before inflation. On those assumptions the five contributions of $15,000 in total would grow to roughly $247,000 by age 65, all of it available tax-free as a qualified distribution.

This is an illustration of compounding over a long horizon, not a forecast. Returns vary, fees reduce growth, and $247,000 in fifty years will buy less than it does today. You can test other assumptions with our future value of an annuity calculator.

Withdrawal rules that matter for a young owner

The Roth ordering rules treat withdrawals as coming first from contributions, then from conversions, then from earnings. Contributions can be withdrawn at any time, at any age, with no tax and no penalty, because they were made with after-tax money. That gives a custodial Roth IRA a degree of flexibility that other retirement accounts lack.

Earnings are different. For a withdrawal of earnings to be tax-free it must be a qualified distribution, which requires both that the account has been open for five tax years and that the owner is 59½, disabled, deceased or using up to a lifetime cap for a first home. A child's account easily satisfies the five-year test by adulthood, but the age test will not be met for decades. Earnings withdrawn before then are taxable and generally subject to a 10% additional tax, with exceptions that include higher education expenses, which waive the penalty but not the income tax. Our guide to the Roth IRA 5-year rule explains how the clock runs, and why an account opened at 15 starts a clock that will matter at 60.

Financial aid, kiddie tax and other side effects

Financial aid. The FAFSA does not ask for retirement account balances, so money inside a custodial Roth IRA is not assessed as a student asset, whereas the same money in a UTMA account or savings account is. Withdrawals are a different matter: distributions taken in the FAFSA base year are counted as income, so taking money out while applying for aid can reduce eligibility. Schools that use the CSS Profile may ask different questions. Check the current form before relying on either treatment.

Kiddie tax. The kiddie tax applies to a child's unearned income above a threshold. Wages are earned income and are not affected, and growth inside the Roth IRA is not taxed at all, so the account does not create kiddie tax exposure. UTMA investment income does.

Social Security and Medicare. Where the child's wages are subject to payroll tax, they also build Social Security earnings credits. That is a small but real benefit of W-2 wages from a non-exempt employer.

When control passes to the child

The custodianship ends at the age set by state law for custodial accounts, 18 in some states and 21 in most, with a few allowing a later age to be specified when the account is opened. At that point the custodian must hand over control, and the brokerage will convert the account to a standard Roth IRA in the child's name. There is no mechanism to delay it or to attach conditions, because the money was always the child's.

Parents should be realistic about this. A nineteen-year-old can withdraw every dollar of contributions with no tax consequence and the earnings with a 10% penalty. The account is a gift of capital, and the lesson in how to leave it alone is yours to teach before the handover, not the custodian's to enforce afterwards.

Common mistakes

• Contributing more than the child earned. The excess is subject to a 6% excise tax every year it remains in the account. The fix is to withdraw it, with its earnings, before the return due date. Our guide to an excess Roth IRA contribution explains the mechanics.
• Treating chores as employment. Paying a child for household chores is an allowance, not compensation, however it is labelled.
• No records. Without a W-2, a return or a log of self-employment income, there is nothing to show the IRS if the contribution is questioned.
• Forgetting to file. Self-employment income above the filing threshold must be reported. A return also creates the paper trail that supports the contribution.
• Assuming the parents' income matters. It does not. Only the child's compensation and the child's modified AGI are tested.

Frequently asked questions

How old does a child have to be to open a Roth IRA?

There is no minimum age. The IRS requires only that the child have taxable compensation for the year. In practice a brokerage will require an adult custodian until the child reaches the age of majority under state law.

Can I contribute to my child's Roth IRA with my own money?

Yes. The contribution is limited by the child's earned income, not by who supplies the cash. A parent's contribution is a gift to the child, which is normally within the annual gift exclusion.

Does babysitting or lawn mowing count as earned income?

Yes, if it is genuinely earned, reported on the child's tax return as self-employment income, and documented. Cash from a parent for household chores does not count.

What happens to a custodial Roth IRA when the child turns 18?

Control passes to the child at the age set by your state's custodial account law, which is 18 in some states and 21 in most. The account becomes a regular Roth IRA in the child's name, and the former custodian no longer has any authority over it.

This article is general education, not personal tax or financial advice. Contribution limits, filing thresholds and state age-of-majority rules change, so check current IRS guidance and your state's law, or speak to a tax professional, before acting.