Accounts for children
Many parents are interested in teaching their children about personal finance. While it is possible for parents to use accounts at financial institutions as instruments in the service of personal finance education, some account types accelerate a journey towards retirement savings.
There are two distinct choices of account type that a parent needs to consider: 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 the child, the age at which the parent wants the child to have access to the funds, the amount of savings and the amount of documentation that the parent is willing to maintain and process.
Children's savings account types
The key differences between the Joint Savings Account and Custodial Savings account are summarized in the table below:
|Feature||Joint Account||Custodial Account|
|Owner||Child and Parent||Parent till child is no longer minor|
|Change in ownership||Not applicable||Depending on the state, ownership changes when child turns 18 or 21|
|Access to funds||Accessible to child while still a minor||Not accessible to child while still a minor|
Other features of the account such as electronics fund transfer (EFT) access, minimum balance and monthly fees depends on the financial institution providing the account.
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 be cognizant of prior to 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year earned (depending upon the amount of interest)||Dividends and capital gains are not taxed as long as funds are not withdrawn from the IRA. Roth IRA rules applicable to adults apply to Custodial Roth IRA accounts and govern the tax treatment of funds withdrawn. In particular, the principal invested can be withdrawn at any time.|
|Change in ownership||Depending on the state, ownership changes when child turns 18 or 21||Ownership changes when child turns 18|
Steps for custodial Roth IRA
- 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 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. A few sample tax returns can be found 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, since the account is a Savings account rather than a Checking account (or an account with a credit facility). Thus an active security freeze at Chexsystems should not affect the account's opening. As always, it is best to check with the financial institution prior to opening an account.
Children can obtain the necessary taxable compensation 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 obtain taxable compensation through modeling or acting. Financial institutions providing Custodial Roth IRA accounts do not police the documentation for a child's income. As such it is up to the child or the parent to maintain adequate documentation. Where the documentation is in the form of a W-2 (employee) or 1099 (independent contractor), documentation is simpler. However, if the child's income is from jobs such as lawn mowing, baby sitting, ice cream stands, etc., the parent and child need to create their own appropriate documentation for the income. Several people have reported successfully funding Custodial Roth IRAs and creating their own documentation. 
Parents should be aware that a child who has self-employment income in excess of $400 must pay self-employment taxes. 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 are not required to pay for 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 avenue for children to obtain taxable compensation and have other tax benefits) and parents should not treat payment for household chores as taxable compensation, 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 compensation and therefore not eligible for Custodial Roth IRAs. The Tax Court has also taken a dim view of considering parents and children in an employer/employee relationship regarding 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 for availability of Custodial Roth IRAs at a specific financial institution, account minimums and other administrative details, it is best to call the financial institution. Online articles written months or years ago may no longer be accurate. As an example, Custodial Roth IRAs at Vanguard had a minimum of $1000 in 2012. 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 stated on the Fidelity site).
Parents / guardians open this account and are responsible for the account activity.
- 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.
- Roth IRA for child, Bogleheads Forum
- Where to start a child's Roth IRA with very low income, MMM Forum
- IRA Kids, irakids.com
- Kids can get a jump on retirement savings with a Roth IRA, Chicago Tribune
- UGMA vs Kids Savings account, Bogleheads Forum
- The Five-Year Rule for Roth IRA Withdrawals, rothira.com
- Roth IRAs for Kids, rothira.com
- Roth IRA for Kids, Fidelity
- Best Broker for a custodial IRA for your kid, The Finance Buff
- IRA Kids, irakids.com
- Kids Savings Account, Capital One
- Beyond the Piggy Bank, Ally
- Child Savings Accounts, Bank of America
- Is Interest on a Minor's Bank Accounts Taxable? Zacks
- My child has interest income from a savings account, Intuit
- When does your child have to file a tax return, Nolo.com
- Paying Taxes on Earned Income, irakids.com
- Phone call with Capital One representative, January 2019
- Start a Roth IRA for your kid, The Military Guide, Doug Nordman, June 11, 2019, Accessed May 26, 2020
- How to Fund Your Roth with Babysitting Money, Megan Russell, February 14, 2020, Accessed May 26, 2020
- What every student should know about summer jobs and taxes, IRS, accessed May 26, 2020.
- Instructions for Schedule SE, IRS, accessed May 26, 2020.
- Household Employer's Tax Guide, IRS, accessed December 11, 2021.
- Roth Rules for Kids, Kiplinger, Janet Bodnar, December 20, 2006, Accessed May 26, 2020.
- Don’t Count Chores When Hiring Your Own Children, Tom Copeland, June 10, 2013, Accessed May 26, 2020.
- Roth IRAs for Minors, Fairmark, Kaye A. Thomas, February 7, 2018, Accessed May 26, 2020.
- T.C. Summary Opinion 2006-127, United States Tax Court, accessed May 26, 2020.
- Denman v. Commissioner, 48 T.C. 439, 450 (1967), United States Tax Court, accessed May 26, 2020.
- Best Broker for a custodial IRA for your kid, The Finance Buff
- Phone call with Vanguard representative, January 2019
- Bogleheads® forum topic: , determined0331. Sep 06, 2019, compares W-2 vs. 1099 tax filing status.