Can I Open a Roth for My Teen?

Dear Carrie,

My 17-year-old daughter has saved $2,000 in income this year from walking dogs and babysitting. Can I open a custodial Roth IRA for her? Should I?

—A Reader

Dear Reader,

Your daughter is lucky to have a parent who's helping her think ahead. Getting kids to start saving early—even for retirement—is one of my personal passions. In fact, as soon as my kids started to have earned income, I helped them open custodial Roth IRAs. And now they're all savers and investors. 

I believe that a custodial IRA can be a great way to introduce a young person to the idea of investing for the long term. Especially these days, with the profusion of online trading platforms that make investing seem like a video game (or even worse—gambling), I like the fact that a custodial account lets you be in the driver's seat for a while to help your teen learn some solid basics before they're on their own.

So yes, the short answer is that you can open a Roth IRA for your daughter with her earnings. Whether you should or not depends on her circumstances. But if you do decide on a Roth, don't just open the account; use it as an opportunity to open doors. Here's how.

First, select the correct account

Just for the record, a custodial account is a bank or brokerage account that an adult (typically a parent) holds for a minor. Although all funds are owned by the minor, the assets are managed by the custodian until the minor reaches the age of majority—at which point the young adult takes complete control.

And while you could also consider a regular custodial brokerage account or a custodial traditional IRA, to me a Roth IRA can make sense for a lot of reasons. At your daughter's age and income (in general, you can only deposit earned income into a retirement account), she doesn't likely need the upfront tax deduction of a traditional IRA. And chances are she'll be in a much higher tax-bracket down the road and will appreciate the potential for tax-free withdrawals of a Roth come retirement. Another plus is that the assets in a traditional or Roth IRA, unlike those in a custodial brokerage account, won't impact her chances for financial aid. 

Make it part of a bigger financial lesson

Saving for retirement is an important lesson, but it's part of a bigger financial picture. This would be a great time to take a step back and talk about goals, both short and long term. What else is your daughter saving for? Maybe some of her earnings could be put toward a shorter-term goal that she can achieve more quickly. Or she could put a portion of her earnings toward college. Make it real by having her write down her goals, and put a dollar amount and a timeline against each one. 

Make sure your discussion of goals and savings includes the importance of having an emergency fund. This will help her—and you—since she won't have to rely solely on "the bank of mom and dad." It will also mean she'll more likely be able to leave her retirement fund intact should something unexpected come up.

Also help her create a monthly budget so she can stay on top of her expenses and carve out money for savings each month. If she doesn't have checking and savings accounts, consider opening those as well. It's all part of helping her become financially fit so she can manage her money wisely for the present as well as the future.

Involve your daughter in the account opening process

It's easy to download and complete an application. But before you do, talk to your daughter about what a custodial Roth IRA is, why it's important for her to save for the future, and how the two of you can work together to manage her money. If she balks at the idea of saving for something such a long way off, make sure she understands that, while the goal is to keep her money growing for the future, one of the advantages of a Roth is that contributions can be withdrawn at any time without tax penalties if she’s in a pinch. Additionally, while a Roth is designed to be a retirement account, the money could be used for her education or even to buy a first home. 

Then complete the application together. Consider making an appointment for the two of you with a financial advisor where you're opening the account. Making the experience personal will make it more meaningful, and will help your daughter see that this is about her money and her future.

Introduce investing

Once the Roth IRA is open and funded, don't stop there. Help your daughter begin to invest by discussing principles such as diversification, not timing the market, not panicking when things go down, and investing for the long haul.

A broad-based stock mutual fund or exchange-traded fund (ETF) is a good way for a new investor to get started. Do some online research together so she can see the types of funds there are, how she can choose investments that align with her feelings about risk, time horizon—even her values. You could help her invest in companies she's interested in by introducing her to fractional shares. Also share your own investment experiences—both good and bad.

Add some personal motivation

Helping your daughter open a custodial Roth with her current earnings is a great first step. If she continues to have earned income, encourage her to keep saving in her IRA each year. As a motivation, you might offer to match her contributions in some way.

Just be aware that while the annual IRA contribution limit for 2021 is $6,000 if you’re under age 50, to make a contribution, you have to have earned income to match. So for instance, if your daughter decided to contribute $1,500 of her $2,000 in earnings this year and put $500 toward another goal, you could offer to put $500 of your own money in her IRA to bring her contribution up to her total earnings.  

Prepare her to take charge

In the not-too-distant future—typically at 18 or 21 depending on the state you live in—she’ll be completely in the driver’s seat and have full control over any money in a custodial account. By teaching her good money management skills now, you'll be helping her learn to use that money wisely. Perhaps even more importantly, you'll be helping her become financially independent and better prepared to take advantage of the many opportunities ahead.

Have a personal finance question? Email us at askcarrie@schwab.com. Carrie cannot respond to questions directly, but your topic may be considered for a future article. For Schwab account questions and general inquiries, contact Schwab.