Many parents are interested in teaching their children about personal finance. Although parents can use ordinary savings accounts to teach their children about personal finance education, some account types could be useful to speed up retirement savings.
There are two distinct account types that parents could use: savings accounts, and Roth IRA accounts. Savings accounts themselves breakdown into Joint accounts and Custodial accounts. The choice of the account type depends on what the parent is trying to teach their child, the age at which they want the child to have access to the funds, the amount of savings, and the paperwork that the parent is willing to deal with.
Children's savings account types
The table below summarizes the key differences between a Joint Savings Account and a Custodial Savings account:
|Feature||Joint account||Custodial account|
|Owner||Child and parent||Parent until the child is no longer minor|
|Change in ownership||Not applicable||Depending on the state, ownership changes when the child turns 18 or 21|
|Access to funds||Accessible to the child while still a minor||Not accessible to the child while still a minor|
Other features of the account, such as electronics fund transfer (EFT) access, minimum balance and monthly fees, depend on the provider.
Custodial savings account vs custodial Roth IRA account
Custodial Savings accounts and Custodial Roth IRA accounts differ in many of the same ways as non-custodial savings accounts differ from Roth accounts. However, there are some additional differences that a parent needs to know about before choosing one account over the other.
|Feature||Custodial savings account||Custodial Roth IRA account|
|Income documentation for minor||Not required||Required|
|Taxable earnings||Interest on savings is taxable in the year earned (depending upon the amount of interest)||Dividends and capital gains are not taxed as long as funds are not withdrawn from the IRA. Roth IRA rules applicable to adults apply to Custodial Roth IRA accounts and govern the tax treatment of funds withdrawn. In particular, the principal can be withdrawn at any time.|
|Change in ownership||Depending on the state, ownership changes when the child turns 18 or 21||Ownership changes when the child turns 18|
Steps for custodial Roth IRA
The steps to open a a custodial Roth IRA are:
- The parent opens a Custodial Roth IRA account with the parent as the custodian. Several financial institutions including Schwab, Fidelity and Vanguard offer Custodial Roth IRA accounts.
- The parent (or the child, if able) records the source, date and amount of income. If the income is recorded on a W-2 or 1099, this step may not be necessary. On the other hand if income is not recorded formally on a W-2 or similar document, detailed records are necessary in case of a future audit or notice from the IRS.
- The parent periodically transfers funds to the Custodial Roth IRA account, up to the Roth IRA limit or the child's taxable compensation, whichever is lower. The parent can transfer the money via check or EFT from their bank account to the Custodial Roth IRA if the financial institution allows it. Alternatively, the parent can open a Children's Savings Account and link that account to the Roth IRA account for periodic transfers. Several banks including Capital One, Ally and Bank of America allow parents to open a Children's Savings Account.
- The parent files a tax return on behalf of the child. There are some sample tax returns at irakids.com. A tax return documents the child's taxable compensation in case the IRS has questions about the Roth IRA.
Children's Savings accounts should not require a credit report pull from Chexystems, because the account is a Savings account rather than a checking account (or an account with a credit facility). As a result, an active security freeze at Chexsystems should not affect opening the account. As always, it is best to check with the financial institution before opening an account.
Children can earn enough taxable income for IRA contributions by working for a business, working as a household employee, or through self-employment. Very young children have few options for legitimate work, but can earn taxable income modeling or acting.
Financial institutions that offer Custodial Roth IRA accounts do not police the sources of a child's income, so the child or the parent has to maintain enough documentation. Where this is a W-2 (employee) or 1099 (independent contractor), documentation is simpler. However, if the child earned money from jobs such as lawn mowing, baby sitting, ice cream stands, and so on, the parent and child need to create their own documentation for the income. Several people have reported successfully funding Custodial Roth IRAs and creating their own documentation. 
However, for several jobs that children may have, such as babysitting, house cleaning, or yard work, they would be classified as household employees, rather than self-employed. Household employers do not have to pay employment taxes if the employee makes less than $2,300 during the year, or if the employee is under 18 any time during the year. Furthermore, IRS Publication 926 states:
If you pay the employee less than $2,300 in cash wages in 2021, none of the wages you pay the employee are social security or Medicare wages and neither you nor your employee will owe social security or Medicare tax on those wages.
Presumably, this would also be true if the employee is under 18 at any time during the year.
Family businesses (which are a good way for children to earn taxable income, as well as for other tax benefits) and parents should not treat payment for household chores as taxable income, either as the basis of an IRA contribution or as a business tax deduction. Opinions are that income earned for household chores is not taxable income, and therefore ineligible for Custodial Roth IRAs. The Tax Court has also taken a dim view of parents and children claiming an employer/employee relationship when it comes to household chores, stating:
Considering these factors and particularly the domestic character of many of the tasks performed, it is our view that these part-time services were in the main part of parental training and discipline rather than the services rendered by an employee for an employer.
To check that a financial institution offers Custodial Roth IRAs, and for any account minimums and other administrative details, it is best to call them directly. Online articles written months or years ago may no longer be accurate. For example, Custodial Roth IRAs at Vanguard had a minimum of $1,000 in 2012. However, as of 2019, there were no minimums for Custodial Roth IRAs at Vanguard, as these accounts are now brokerage accounts with $0 minimum, rather than mutual fund accounts that have a higher minimum.
Fidelity Youth Account
Fidelity offers a non-custodial account for teens 13 to 17 years old. The teen is the account owner and will get a free debit card. There are no account fees or minimums (subject to restrictions listed on the Fidelity site).
Parents or guardians open this account, and are responsible for the account activity. Some relevant links:
- Fidelity Youth Account - Start here.
- Frequently asked questions (FAQs)
- Teens and Money - Fidelity's Learning Center. A library of jargon-free, 101-level educational content that explains financial concepts simply.
- Bogleheads forum topic:
- "Where to start a child's Roth IRA with very low income". MMM Forum. Retrieved August 31, 2023.
- "IRA Kids". irakids.com. Retrieved August 31, 2023.
- "Kids can get a jump on retirement savings with a Roth IRA". Chicago Tribune. Retrieved August 31, 2023.
- Bogleheads forum topic: .
- "What Is the Roth IRA 5-Year Rule? Withdrawals, Conversions, and Beneficiaries". Investopedia. Retrieved August 31, 2023.
- "Starting an IRA for Your Child: The Benefits". Retrieved August 31, 2023.
- "Roth IRA for Kids". Fidelity. Retrieved August 31, 2023.
- "Best Broker for a custodial IRA for your kid". The Finance Buff. Retrieved August 31, 2023.
- "Kids Savings Account". Capital One. Retrieved August 31, 2023.
- "Beyond the Piggy Bank". Ally. Retrieved August 31, 2023.
- "Child Savings Accounts". Bank of America. Retrieved August 31, 2023.
- "Is Interest on a Minor's Bank Accounts Taxable?". Zacks. Retrieved August 31, 2023.
- "My child has interest income from a savings account". Intuit. Retrieved August 31, 2023.
- "When does your child have to file a tax return". Nolo.com. Retrieved August 31, 2023.
- "Paying Taxes on Earned Income". irakids.com. Retrieved August 31, 2023.
- Phone call with Capital One representative, January 2019.
- Doug Nordman (June 11, 2019). "Start a Roth IRA for your kid". The Military Guide. Retrieved August 31, 2023.
- Megan Russell (February 14, 2020). "How to Fund Your Roth with Babysitting Money". Retrieved August 31, 2023.
- "What every student should know about summer jobs and taxes" (PDF). IRS. Retrieved August 31, 2023.
- "About Schedule SE (Form 1040), Self-Employment Tax". IRS. Retrieved August 31, 2023.
- "About Publication 926, Household Employer's Tax Guide". IRS. Retrieved August 31, 2023.
- Janet Bodnar (December 20, 2006). "Roth Rules for Kids". Kiplinger. Retrieved August 31, 2023.
- Tom Copeland (June 10, 2013). "Don't Count Chores When Hiring Your Own Children". Retrieved August 31, 2023.
- Kaye A. Thomas (February 7, 2018). "Roth IRAs for Minors". Fairmark. Retrieved August 31, 2023.
- "T.C. Summary Opinion 2006-127" (PDF). United States Tax Court. August 21, 2006. Retrieved August 31, 2023.
- "Denman v. Commissioner, 48 T.C. 439, 450 (1967)". Leagle. June 26, 1967. Retrieved August 31, 2023.
- Phone call with Vanguard representative, January 2019.
- Bogleheads forum topic: , determined0331. September 6, 2019, compares W-2 vs. 1099 tax filing status.