BENEFITS OF A CUSTODIAL ROTH IRA FOR KIDS AND TEENS
- KidVestors
- Mar 29, 2025
- 9 min read
Updated: 2 days ago
What you'll learn:
So, you’re thinking about the financial future of your child. Kudos to you! With more than half of adults concerned about being able to retire comfortably, imagine if we were able to go back and time and change that. Imagine if you could go back in time and start investing as a kid. With all those years ahead, even the smallest contributions could grow into something substantial.
A Custodial Roth IRA is one of the best tools to teach your kids and teens the value of investing. Setting up an investment account for your kids isn’t just wise—it’s potentially life-changing. You’re not only giving them a head start on saving for the future, but you’re also teaching them valuable lessons about money and investing.
What Is a Custodial Roth IRA?
A Custodial Roth IRA is a retirement account set up by a parent or guardian on behalf of a minor. While a traditional Roth IRA is something you usually open as an adult, the custodial version allows kids to start early. Think of it as a "forever gift" for your child.
For kids, investing early means more time for their money to grow—and this is where compound interest, or “the snowball effect,” comes into play.
Compound interest is like a magical formula that makes your money work harder the longer it sits. Imagine you’re rolling a tiny snowball down a hill. At first, it’s small, but as it rolls and picks up snow, it gets bigger and bigger until—boom!—you have a giant snow boulder. Compound interest works the same way. Your child’s investments earn a little return, then those returns start earning returns of their own. And over a few decades, that little initial investment can grow into a pretty hefty sum.
Opening a custodial roth IRA account for your child is like buying a gift that won’t get used right away but will appreciate significantly over time. Think of it as planting a seed in a “money tree” that’ll take a few decades to grow—by the time it’s fully bloomed, your child can use it for important life milestones. And yes, while it’s officially a “retirement” account, a Custodial Roth IRA actually offers multiple benefits that can come in handy sooner.
But, there’s a catch! For your child to have a Custodial Roth IRA, they need to have earned income. In other words, your kid needs to have made some money. Babysitting, mowing lawns, or that part-time job at the smoothie shop can all qualify. If they have earned income, they’re in the clear!
Where Can You Open a Custodial Roth IRA for Your Child?
There are several reputable financial institutions where you can open a Custodial Roth IRA for your kid. Here are a few options to consider:
Fidelity: Known for its low fees and excellent customer service, Fidelity offers custodial Roth IRAs with no minimum balance requirements.
Charles Schwab: Schwab’s user-friendly platform makes it easy for parents and young investors to get started. They offer a variety of resources to help you and your child learn more about investing.
Vanguard: A favorite among long-term investors, Vanguard is a solid option if you’re looking for low-cost index funds and ETFs within your Roth IRA.
Each of these platforms offers online access, making it easy to manage the account and track growth over time.
Custodial Roth IRA vs. Custodial Brokerage Account: Which One Fits Your Kid’s Goals?
While both accounts are under the “custodial” umbrella and offer investment opportunities, they serve slightly different purposes:
Custodial Roth IRA: This is a retirement account with tax-free growth, and contributions can be withdrawn without penalties. However, earnings can only be accessed without penalty after age 59½ (with some exceptions).
Custodial Brokerage Account: This is a taxable account where you and your child can invest in stocks, bonds, mutual funds, etc. There are no penalties for withdrawals, but it does incur taxes on gains. This type of account is ideal for shorter-term goals, like saving for college or a car.
To sum it up: if your child wants to keep their money growing for the long haul, the Custodial Roth IRA is a great fit. If they have shorter-term savings goals, the Custodial Brokerage Account might be more their speed.
Kids IRA - Growing Money, Tax-Free
Here’s the best part: Unlike custodial brokerage accounts, custodial Roth IRAs grow tax-free! Since contributions are made with post-tax dollars (money that’s already been taxed), there’s no tax bill down the line for withdrawing these contributions. And any earnings? Tax-free after age 59½.
In the meantime, your child’s contributions (the money you deposit), can be withdrawn tax-free at any time. This tax-free status can make a world of difference over the long run, especially if your child continues to invest over their lifetime. Imagine that: tax-free growth, all because you helped them start early!
Custodial Roth IRA For Kids Eligibility Requirements: The “Earned Income” Rule
Regarding the "catch" we talked about earlier? Well, in order to open a custodial Roth IRA, your child must have earned income, which is money they’ve made from a job or self-employment. But here’s the kicker; the amount they contribute can only be up to the amount they earned. So, if your child earned $2,000 this year babysitting, they can contribute up to $2,000 into their Custodial Roth IRA.
What Counts as Earned Income for a Custodial Roth IRA?
One of the biggest misconceptions parents have about custodial Roth IRAs is assuming that any money their child receives can be contributed to the account.
Unfortunately, that is not how it works.
According to IRS rules, Roth IRA contributions must come from earned income. That means the child or teen must actually earn money through legitimate work or services performed.
This is important because simply giving your child money, paying an allowance, or transferring birthday cash into a Roth IRA generally does not qualify.
Think of it this way:
The IRS wants Roth IRA contributions tied to actual work, not gifts.
What Is Considered Earned Income?
Earned income generally includes taxable income earned from working.
For kids and teens, common examples may include:
Babysitting for other families
Lawn mowing for neighbors or clients
Tutoring
Working a part-time job
Acting or modeling income
Dog walking or pet sitting
Freelance creative work
Self-employment income
Summer jobs
Restaurant or retail employment
If your teenager works at a local coffee shop and earns $3,000 during the summer, they may generally contribute up to $3,000 to a custodial Roth IRA for that year.
What Does NOT Count as Earned Income?
This is where many families accidentally make mistakes.
The following are generally not considered earned income for Roth IRA purposes:
Birthday money
Holiday gifts
Investment income
Money from household chores for parents
Gifts from grandparents
Inheritance money
For example:
If your child earns money mowing lawns for multiple paying neighbors, that may qualify as earned income.
But if they mow your own lawn as part of normal household responsibilities and you pay them an allowance, that generally would not count as earned income according to IRS guidance.
The distinction is whether the child is being paid for legitimate services performed in a business or employment context versus routine household expectations.
Can Parents Employ Their Children?
In some situations, yes.
Parents who own businesses may be able to legally employ their children for legitimate work performed for the business.
Examples may include:
Modeling for company marketing
Filing paperwork
Cleaning office spaces
Administrative work
However, the work should be legitimate, age-appropriate, properly documented, and compensated reasonably.
Families should maintain records such as:
Timesheets
Payroll documentation
Invoices
Payment records
Tax filings if applicable
This is especially important if contributions are ever questioned by the IRS.
Benefits and Uses of a Roth IRA For Kids: More Than Just Retirement Savings
A Custodial Roth IRA has several amazing uses:
Tax-free growth: As we mentioned earlier, this account grows tax-free over the years, creating a solid foundation for their financial future.
Flexibility: Contributions (but not earnings) can be taken out at any time. They can even be used toward education or their first home purchase.
First home: Your child can use up to $10,000 of Roth IRA earnings (without penalty) to buy their first home, giving them an early boost toward real estate investing.
Education costs: Withdrawals can be used toward qualified education expenses without the usual Roth IRA penalty (though earnings would be taxed).
Each of these benefits makes the Custodial Roth IRA one of the most flexible investment accounts for young people. And by teaching them to think about this money as a long-term investment, you’re helping to instill a powerful financial habit.
Custodial Roth IRA Withdrawal Rules: What You Need to Know
A Custodial Roth IRA is a great way for teens to start investing early, but what happens when it’s time to withdraw the money? Unlike traditional retirement accounts, Roth IRAs let contributions grow tax-free, but there are some rules to follow.
First, the money you contribute (not the earnings) can be withdrawn anytime, tax- and penalty-free. That means if a teen deposits $1,000, they can take out that $1,000 whenever they want. But if they try to withdraw earnings (the money that grows over time) before age 59½, they could face taxes and a 10% penalty—unless they qualify for an exception.
Some penalty-free reasons for early withdrawals include using the funds for college expenses, a first home purchase (up to $10,000), or certain emergencies. Otherwise, it's best to leave the money alone and let compound interest do its thing.
A Custodial Roth IRA is a powerful tool for building wealth, but patience pays off. The longer the money stays in, the more it grows—making future withdrawals way more rewarding!
Financial Literacy: The Key to Long-Term Financial Health
While a great first step, simply opening an account isn’t enough—it’s equally important to teach kids how investing works. Financial literacy skills are vital, as they empower your child to make smart financial decisions and build wealth over time.
Investing may feel intimidating for kids at first, but learning early pays off in more ways than one. And you don’t have to do it alone! That’s where KidVestors comes in.
At KidVestors, we make financial literacy fun and engaging for kids. We believe that learning how to manage money shouldn’t feel like a chore, so we use avatars and games, animated videos, and interactive activities that capture kids’ interest and make learning about money enjoyable. Your child will learn the basics of saving, investing, entrepreneurship and smart spending—key skills that can serve them well throughout life.
Our platform also includes virtual stock trading across global exchanges, so kids can practice investing in a safe, risk-free environment. They can explore how stocks grow over time, experiment with different strategies, and get a feel for how the market works, all while earning KV Bucks™ rewards along the way to convert into REAL CASH. And for you, it’s peace of mind that your child is building financial knowledge they’ll carry with them into adulthood.
Building Financial Knowledge, One Investment at a Time
Opening a Custodial Roth IRA is more than just setting up a retirement account—it’s a valuable opportunity to introduce your child to the power of investing and compounding interest. By helping them start young, you’re giving them a solid financial foundation, and with KidVestors by your side, they’ll have the tools to grow into savvy, confident investors. Let’s make the future bright—one investment at a time!
Get started with KidVestors today
Frequently Asked Questions About Earned Income and Custodial Roth IRAs
Can my child contribute birthday money to a Roth IRA?
No. Birthday money and gifts generally are not considered earned income and therefore usually cannot be contributed directly to a custodial Roth IRA.
Does allowance count as earned income?
Typically no. Standard allowance payments and payments for normal household chores generally are not considered earned income for Roth IRA purposes.
Can babysitting income qualify for a custodial Roth IRA?
Yes. Babysitting income may qualify as earned income if the child is legitimately providing services and earning money.
Can my child contribute more than they earned?
No. Roth IRA contributions generally cannot exceed the child’s earned income for the year.
Does lawn mowing count as earned income?
It can. Lawn mowing for paying neighbors or clients may qualify as earned income. However, mowing your own family’s lawn as part of household chores generally does not.
Can parents hire their children through a family business?
In some cases, yes. Children may be employed by a family business for legitimate work performed, but families should maintain proper documentation and follow IRS guidelines.
Does investment income count as earned income?
No. Dividends, stock gains, interest income, and other passive investment income generally do not qualify as earned income for Roth IRA contributions.
What is the benefit of a custodial Roth IRA?
A custodial Roth IRA allows kids and teens with earned income to start investing early, potentially benefiting from decades of compound growth and tax-free qualified retirement withdrawals later in life.
FINANCIAL LITERACY FOR STUDENTS
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