Custodian Roth IRA account for kids

momopi

momopi

Well-known member
Couple weeks back, I submitted an application to open a custodian Roth IRA account for my daughter at Vanguard. However, after speaking with my accountant, she informed me that the account can only be funded by my child's "earned income" and money given to her for doing chores (folding laundry) is not acceptable. Since she is 4, obviously this wouldn't pass IRS audit. So I called Vanguard to cancel the application, then called back to verify that it was cancelled.

Few days after, I received an email from Vanguard to inform me that the account has been opened and money has been transferred to the account's settlement fund. I logged into Vanguard and verified that the Custodian Roth IRA account was created, then called back to resolve the issue which turned out to be a trip down the rabbit hole.

After multiple phone calls with different Vanguard departments, this is what I found:

If you submit an account application by mistake, the department that you need to speak to is the Onboarding Group. I made the mistake of speaking with general customer/account support group and the application cancellation was not processed, nor did know to send a message to the Onboarding Group.

If the IRA account application has been processed-opened-funded, the department that you need to speak to is the Retirement Group. The process to remove the funding before account can be closed is called "Excess Removal". General customer/account support and Onboarding Group cannot resolve the issue at this point, you must speak the Retirement Group to request Excess Removal then account closure. The general customer support group and Onboarding group may not always know to route you to the correct department (Retirement Group).

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I got the correct information & contact groups by demanding to speak to the supervisor.
 
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If you still want to fund your daughter's Roth IRA, a potential work around is the new rule that allows unused 529 funds to be rolled over to a Roth IRA when they are older. One of the items on my to-do list is to study the optimal strategy for taking advantage of this, or if it would even be worth it. (In the past, I haven't really been a fan of 529 accounts, because they are pretty rigid about what you can invest in.) Maybe I will post my findings here when I have more to share.
 
Liar Loan said:
If you still want to fund your daughter's Roth IRA, a potential work around is the new rule that allows unused 529 funds to be rolled over to a Roth IRA when they are older. One of the items on my to-do list is to study the optimal strategy for taking advantage of this, or if it would even be worth it. (In the past, I haven't really been a fan of 529 accounts, because they are pretty rigid about what you can invest in.) Maybe I will post my findings here when I have more to share.
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I have a 529 account for my daughter at Vanguard, which actually has a decent selection of investment options:

Vanguard Investment Products List

investor.vanguard.com investor.vanguard.com

I skipped right over the target date funds and put 100% into index fund. As she gets older and closer to college, maybe I'll re-allocate to 60/40.
 
From fidelity:

If your child is not filing a tax form that reports his or her earned income, consider maintaining a written log of their earnings in case the IRS asks questions. Unlike traditional IRAs, contributions to Roth IRAs are made with after-tax dollars. This means the account owner cannot claim a tax deduction for his or her contributions. However, since most kids have low annual earnings, their income tax rate is already quite low or even zero. Therefore, tax deductions may not be an important factor at this stage of their lives. Moreover, when it comes time to tap their savings at retirement age, certain qualified distributions from a Roth IRA will be tax-free, unlike distributions from a traditional IRA.

www.fidelity.com

Custodial Roth IRA: Your guide to Roth IRAs for kids | Fidelity

Learn how parents, grandparents and other family members can jumpstart their children's retirement including custodial Roth IRA.
www.fidelity.com

The likelihood of getting audited has to be pretty small. I think the bigger issue is your kid is 4 :) - and no one is hiring a 4 year old. So maybe the age itself will trigger an audit :)

The limit for 2024 is 7K or $134/week. Once your kid is working age (maybe 7-8??) you can probably move forward with it. Just keep your log. I know one person doing this for their kids and they have not been audited
 
Going further down the rabbit hole...

So the Vanguard Retirement Group could not perform the excess removal until the funds has settled. I had to wait until today to call back and make the excess removal request.

The Retirement Group support person filled out an excess removal form and send it to me online. I was not able to open the document on 3 different computers (2 Windows and 1 Mac) using 3 different browsers. Then I tried it on my iPad, same thing. He sent the form again and I could not open the 2nd one either.

So I followed his instructions to try and access/generate the form manually online from my end, and again it would not open/load on my browser. All I'm seeing is a blank screen or rotating circle.

He indicated that he was not able to get tech support on the call and must submit a ticket to them. So he has to submit the ticket and mail me a hard copy of the excess removal form, which I have to sign and mail back.
 
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Oh man, sorry to hear all this hassle you have to go through! The dysfunction in our systems is something else..
 
I, a many decade Vanguard customer, feel that their customer service really took a dive in the past few years. They forced all of the vanilla mutual fund holders to convert to online brokerage accounts, and now are demanding $25 for each phone call, and $100 to close out an account.
 
Also, for the Roth for kids, I keep a paper/spreadsheet log of kids earnings (can't be chores/allowance; think babysitting or dog walking for neighbors or anything you yourself might hire someone else to do) once they turned 12. I 100% match their earnings as a deposit into their Fidelity custodial Roth accounts (so they retain their earnings in whole).
 
I figured out the issue with accessing the "Excess Removal" form online.

For whatever asinine reason, when you click on the link to access the form it dumps you to the "Excess contributions, recharacterizations and Roth conversions" page and by default, there is no form or document displayed. By clicking on "next" you will get "There are no available next states to go to" message.

To view or review the selections, you need to click on "Account type selection" (or another on the list) tab on left side, then click "next" to review through the form before the PDF can be generated, signed and submitted.
 
freedomcm said:
I, a many decade Vanguard customer, feel that their customer service really took a dive in the past few years. They forced all of the vanilla mutual fund holders to convert to online brokerage accounts, and now are demanding $25 for each phone call, and $100 to close out an account.
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I've been a Vanguard customer for over 2 decades and I'm inclined to agree. If you look at John Bogle's keynote at Bogleheads convention in 2018, he was still mentally sharp and kept a close eye on the company. Like James Sinegal (former Costco CEO & Co-Founder), even in retirement, nobody dares to raise the price on $1.50 Costco hotdog. But with Vanguard, after Bogle's passing in 2019 his successors are slowly raising price and reducing size of the "hotdog" to customers. There are numerous other issues like dated website/UI/UX, decline in customer service training/experience, increased competition (Fidelity zero fee funds) and so on.


freedomcm said:
Also, for the Roth for kids, I keep a paper/spreadsheet log of kids earnings (can't be chores/allowance; think babysitting or dog walking for neighbors or anything you yourself might hire someone else to do) once they turned 12. I 100% match their earnings as a deposit into their Fidelity custodial Roth accounts (so they retain their earnings in whole).
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My initial thought was that if I could start putting $100/month into my 4-year old daughter's IRA account for next 14 years, with 100% invested in S&P 500 index fund with average 10% annual returns, she'd have $36,380.92 at 18. With no additional money invested into the account, it will grow to $3,214,406.39 after another 45 years when she is 63.

In comparison, if the account was started later at say age 18, with $100/month invested for next 45 years, she'd have $1,048,250.17 at 63.

The power of compounding interest is both awesome and terrifying. I cannot reasonably justify a Roth IRA account for my 4 year old and, unlike 529 plan, UGMA/UTMA account will have (larger) negative impact her student financial aid eligibility. So, in addition to her 529 plan, I'll open another investment account under my name to deposit $100/month for next 14 years.
 
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@momo - with the Roth IRA that $3M you calculated is completely tax free. I would start it at around 8 years old. Keep your excel file with a log of the work they have done and start funding it.
 
Stuffing money into a roth IRA at a young age and making killer gains is a great idea and it's certainly important to document the earned income on a paper or spreadsheet, but it doesn't stop there, your child needs to report the income on their tax return (and likely pay self employment tax), so check with your CPA on that. No earned income -> not eligible for roth IRA contributions. Earning income without reporting it on a tax return -> tax fraud.
 
freedomcm said:
it seems you are saying the UGMA will affect her financial aid, but the 529 will not? I was under the (mis?) understanding that both would reduce her college aid-is this not correct?
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In general, 529 plans reduce aid eligibility by up to 5.64% of the asset value, versus UGMA will reduce aid eligibility by 20% of the asset value.


qwerty said:
@momo - with the Roth IRA that $3M you calculated is completely tax free. I would start it at around 8 years old. Keep your excel file with a log of the work they have done and start funding it.
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The $3 million calculation assumes $36,380.92 in her account at age 18 plus another 45 years of compounding interest. As soon as she is old enough to get a part time job somewhere, I could just start stuffing her Roth IRA account until the desired amount is reached in her 20's.

If she has $60,000 invested in her Roth IRA at age 25, assuming 10% returns (S&P 500) for 40 years, the account will grow to $3,222,039.79 at age 65.
 
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My plan is to have the kids max out the Roth IRA and 401ks as soon as they start working. I can always help supplement their income if needed to ensure they fund both as soon as they start working.
 
someguy said:
Stuffing money into a roth IRA at a young age and making killer gains is a great idea and it's certainly important to document the earned income on a paper or spreadsheet, but it doesn't stop there, your child needs to report the income on their tax return (and likely pay self employment tax), so check with your CPA on that. No earned income -> not eligible for roth IRA contributions. Earning income without reporting it on a tax return -> tax fraud.
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I've read that filing a return for a kid who earns less than ?$7k? is not necessary for contributing to a Roth IRA. But I am happy to hear input from others who might know better.

Someguy-are you a tax pro?
 
qwerty said:
My plan is to have the kids max out the Roth IRA and 401ks as soon as they start working. I can always help supplement their income if needed to ensure they fund both as soon as they start working.
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That early start, or early lump sum is critical in achieving critical mass for the snowball rolling downhill.

Using my earlier example of 59 year investment span for my 4 year old, if I invest $100/month from ages 4-18 (14 years) into S&P 500 and stop contribution at age 18, the account will grow to $3,214,406.39 over the following 45 years when she reach age 63.

In comparison, if $100/month is invested continuously for 59 years, she will end up with estimated $4,262,656.57. In other words, the first 14 years of investment is worth $3.2 million vs the latter 45 years of investment is worth $1 million down hill.

You could also replicate the same result by putting $36,380.92 into S&P 500 index at by age 18, or $60,000 by age 25 via lump sums.
 
freedomcm said:
I've read that filing a return for a kid who earns less than ?$7k? is not necessary for contributing to a Roth IRA. But I am happy to hear input from others who might know better.

Someguy-are you a tax pro?
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The nuance is whether the kid is earning income from a w2 job vs earning income from self employment (babysitting, dog walking, etc).

For a kid with w2 income of less than $13,850 (for 2023) there is no need to file a tax return because they would no have a tax liability. The earnings record would be with the IRS via the w2 reported by the employer. So if a kid had w2 income of $5k, you could put up to $5k into a Roth IRA and not file a return.

For a kid with self employment income of over $400 for 2023 they would need to file a tax return. The self employment itself will trigger the self employment tax. If a kid made $5k in self employment income the kid would have to file a tax return and pay the self employment tax
 
qwerty said:
The nuance is whether the kid is earning income from a w2 job vs earning income from self employment (babysitting, dog walking, etc).

For a kid with w2 income of less than $13,850 (for 2023) there is no need to file a tax return because they would no have a tax liability. The earnings record would be with the IRS via the w2 reported by the employer. So if a kid had w2 income of $5k, you could put up to $5k into a Roth IRA and not file a return.

For a kid with self employment income of over $400 for 2023 they would need to file a tax return. The self employment itself will trigger the self employment tax. If a kid made $5k in self employment income the kid would have to file a tax return and pay the self employment tax
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I'm starting to think the 529 ->Roth IRA conversion is the best strategy for young kids. The kids wouldn't need earned income and you don't run the risk of self-employment tax. If you are one of the ballers earning $350k on this board, are you really going to qualify for financial aid anyway?
 
To many restrictions on the 529 to Roth conversion

www.fidelity.com

Understanding 529 rollovers to a Roth IRA

529 beneficiaries can convert a portion of unused funds to a Roth IRA starting in 2024.
www.fidelity.com

Ultimately the goal is to have the kids have 60k or so in a Roth by the time they are 18.

If at 18 they have 60k in the Roth account and contribute 6k per year until 58 (40 years, assuming they stay under the income limit) the 60k and annual 6k contribution with a 7% return would turn into about 2.2M of tax free dollars. An 8% return would be $3.1M. A 9% return would be $4.2M. A 10% return would be $5.9M. Without the 60k starting pot at 18 and a 10% return the $5.9M at 58 become $3.2M
 
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