Years ago when my oldest child started her first job as a life guard for the local pool system, I pondered how I could motivate her to contribute to a Roth IRA. I settled on a tactic that's used by employers everywhere: matching contributions.
My contribution rules are simple:
- I match contributions dollar-for-dollar This places an upper limit of $3,250 (2023) on my match.
- When Daddy's paying tuition, he doesn't match. My budget can only take so much!
Why a Roth IRA?
When a child starts earning money, they are usually in the zero tax bracket. By contributing to a Roth IRA, they will never pay taxes on it again.
Another advantage of contributing to a Roth IRA is that FASFA financial aid calculations ignore Roth IRAs. However, the FASFA expects savings and brokerage accounts to help pay for school, putting these types of accounts at a disadvantage. If you don’t plan on using financial aid for school, this isn’t a concern.
Is it legal?
A child can contribute to a Roth IRA if they have earned income. They are limited by how much they earn. You can only contribute to your own Roth IRA and not to someone else's IRA. But money is fungible. My "contribution" is ultimately a cash gift to my child once they make their contribution. If they earn $1,000 and contribute all $1,000 to their IRA, I then gift them $500. In effect, I’ve matched their contribution. The child is still limited by how much earned income they had for the year. You can’t "match" more than they’ve earned.
The IRS restricts the types of income a child can contribute to their IRA. Getting paid for babysitting the neighbor's children counts (with documentation and a tax return stating the income), but money earned from babysitting a sibling doesn't. Income from a family-run business can count with proper documentation. Children who contribute to an IRA will need to file a tax return, but at their age it should be a simple return.
Contribution Amount
Should you contribute as much as I do? No. Choose something that works for you. Even if it’s a small amount, your child should learn early that contributed money is free money, hopefully applying this lesson to future employment.
An alternative approach taken by Frugal Professor is to match 7.65%, the amount of their FICA taxes.
Where Can I Open My Child's Account?
Many brokerages offer custodial IRA accounts. I have experience using both Vanguard and Fidelity.
Vanguard's Custodial IRA
I have both IRA and brokerage accounts at Vanguard and I've found that Vanguard has index funds and ETFS with low fees. Setting up custodial Roth IRAs at Vanguard for my first two children was straightforward, but I couldn't do it online. Instead, Vanguard messaged me a paper-based manual "kit" that we then printed out and mailed back, along with an initial check to fund their account. Vanguard had the account setup within 48 hours of my snail mailing it, even though the intervening day was a holiday. Remarkable.
Subsequent contributions were all made online. I've encouraged them to go all in on the index fund VTSAX with a 0.04% expense ratio.
Fidelity's Custodial IRA
For child #3 and #4, I went with Fidelity. Like Vanguard, Fidelity offers low cost index funds and ETFs. Unlike Vanguard, I was able to set them up online.
Because my kids have years of compounding, I encouraged them to invest it all in FZROX with a 0% expense ratio.
Final Thoughts
In 2023, I expect to match contributions for only child #3 and #4. Their older siblings are in the "Daddy's helping with tuition"-phase, and their younger sibling are too young to be earning anything. If my children maximize their match, I'll be contributing a total of $6,500 to their IRAs in 2023. Drawing from past experience, I suspect it will be short of the full amount.
My hope is that by providing a generous match today, I can direct them to a lifelong habit of IRA contributions. It seems to have worked well for the first two and it seems something I can sustain for the next decade at least.