Roth IRAs and Children: Never Too Early to Save

You want your child or grandchild to be financially secure—not just now but throughout life. A great way to get a kid started on that path is through a Roth IRA. What is a Roth IRA? Contributions to a Roth Individual Retirement Account (IRA) do not qualify for an immediate income tax deduction; but a child is in a low tax bracket, so a tax deduction is not meaningful. Most important, qualified withdrawals from Roth IRAs are income-tax-free, and there is not a required minimum distribution at age 70 ½ like a traditional IRA, so a Roth IRA can grow tax-free for many years.

Yes, children can contribute to a Roth IRA, or you may do it on their behalf. Either way, by laying the groundwork of saving now, you can help them achieve a secure retirement. In the process they’ll get an early education in personal finance. With many adult Americans woefully illiterate about finance, your kid will be ahead of the pack before they even graduate from college.

How It Works

You can set up a Roth IRA as soon as your child or grandchild starts earning income. That money can be W-2 wages, or it can be self-employment income, like babysitting. An allowance does not count as earned income, but if you own a business, you can employ the child. The job must be age-appropriate, and the wages must be at the market rate.

A bonus to the Roth IRA is that the IRS doesn’t care who contributes to the account. It can be a child, a parent or a grandparent. So, for example, if you want to set up an agreement that for every dollar the child earns, you’ll put a dollar in their Roth IRA, that’s perfectly fine. The only requirement is that the total amount contributed to the account cannot exceed the amount the child earned.

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A couple of other points:

  • You can contribute as much as $5,500 to a Roth IRA annually. This amount is set by the IRS and will likely change over the years.
  • You can contribute as much as $400 in self-employment income without having to worry about paying Social Security or Medicare taxes. Make more than $400 and a tax return will need to be filed.
  • If a child does not receive a W-2 for the work they do, they need to keep records—which can be a great lesson in organization and responsibility. The records should include the type of work they did, when and who they did it for, and how much money they made.
  • You’ll likely be the custodian for the account until your child or grandchild reaches adulthood—age 18 or 21 depending on the state. After that, they’ll take control of the account.

Using the Roth IRA for Life’s Milestones

Roth IRAs offer flexibility that other retirement accounts don’t. Because they’re funded with after-tax dollars, the contributions can be withdrawn before retirement without penalty or taxes. Not so for the earnings—a nonqualified withdrawal before age 59 1/2 will incur taxes and a 10% penalty.

When it comes to buying a first-time home, the Roth can prove especially helpful since the purchase counts as a qualified withdrawal. So, in addition to contributions, a first-time homebuyer can tap into earnings of up to $10,000 as long as the account is at least five years old and the money is used for the down payment, closing costs and related expenses.

Flexibility like this makes Roth IRAs very attractive. Of course, if your child or grandchild can buy their first home without dipping into their account, all the better since it will leave more for retirement.

One final point: By getting a child saving early, the Roth IRA becomes an effective vehicle for transferring wealth from one generation to the next. Ultimately, your heirs may have a sizeable retirement savings before they even start their career.

As always, consult with a qualified tax advisor about your personal financial situation.

Retirement Saving Starts with Your Teen

Is your teenager thinking about retirement? Have you ever wondered how to teach your teen about investing? Whether it's your child or grandchild, a Roth IRA is a great way to start a teen's retirement savings and teach them about investing.

The Advantage of a Roth IRA

Why a Roth IRA? Teenagers are in a very low tax bracket, so a traditional IRA (where contributions are tax deductible) will be of little value. A Roth IRA does not offer a current tax deduction, but withdrawals in retirement are tax-free, there is no required minimum distribution at age 70½, and there are special provisions for early withdrawals if needed.

You can contribute 100% of your teen's W-2 income to a Roth IRA, up to $5,000 for 2012 or $5,500 for 2013. You can contribute up to $400 of "self-employed" income (such as what they earn from baby-sitting or lawn mowing) to be reported on Schedule C of their tax return; in addition, you'll avoid paying any FICA payroll tax on up to $400 of that income. So, you can even start a Roth IRA for a 12-year-old who does some baby-sitting or lawn mowing. For example, if your 15-year-old makes $1,200 working at a fast food joint or retail store, you can contribute up to $1,200 to a Roth IRA.

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You can continue funding a child's or grandchild's Roth IRA into their early 20s, as they start their first job out of college. The ability to contribute to a Roth IRA is phased out for those who make over roughly $100,000 (which would likely only apply to professional athletes or rock stars). If you fund a Roth IRA from age 15 to age 30 or so, your teen can be well on their way to retirement.

Start Teaching Your Teen About Investing

The Roth IRA is a great way for your teen to learn about investments and see how the contributions make their Roth IRA account grow.

You can still open a Roth IRA for 2012 income. The deadline is the date you file their 2012 income tax return, prior to or on April 15, 2013.

Your teen may not thank you for many years, but isn't that typical?

About Bruce J. Berno, CFP® Bruce J. Berno, CFP® is the founder of Berno Financial Management, Inc. a fee-only comprehensive personal financial planning and investment advisory firm headquartered in Cincinnati, Ohio. Since 1993, Berno Financial Management has been helping individuals and families achieve financial peace of mind. For more information about Berno Financial Management, visit

Where Does Your Money Go?

Are you saving more money than you want to or planned? Probably not. Does it seem that even when your income goes up you can’t save more money? Where does your money go? How much money are you saving? If you have a hard time answering these questions―and most people do―there are some easy solutions.

First, try a manual or “back of the envelope” approach. Start by identifying your annual income from your W-2 tax wage statement or year-end payroll stub. Then identify how much you contributed to investment accounts like your 401(k), IRA or 529 college savings plans. Next, calculate how much cash you accumulated or depleted by comparing your bank account balances from the beginning of the year to your balances at the end of the year. If your bank account balances were higher at the end of the year than at the beginning, you accumulated cash. If they were lower, you depleted some cash.

To calculate the percentage of your income that you saved, divide the amount you contributed to investment accounts plus any cash that you accumulated minus any cash that you depleted by your annual income total. For example, if your annual income was $100,000 and you contributed $15,000 to your 401(k) and accumulated $5,000 in your bank accounts, you invested or saved $20,000 or 20% of your income. That is very good and you may be able to stop here, unless you want to learn more about where you are spending your money so that you can try to save even more.

If your income was $50,000 and you contributed $1,500 to your 401(k) and $500 to a 529 college savings plan and your bank balances remained about the same, then you saved 4% of your income. Obviously, the higher your income, the greater percentage you should be able to save. However, it doesn’t always work out that way, as people tend to ratchet up their lifestyle spending as their income increases. As a general rule, you should try to save 10% to 25% of your income. Saving 5% is better than nothing, but it’s probably not enough to accumulate a retirement nest egg in the long run.

What technological resources are available to help you boost your savings? You have a wide range of options to choose from. Your bank website may have a resource to help classify and summarize expenses. Your credit card company may provide an annual statement that shows you how much you spent in certain categories. Check out the “restaurant” or “entertainment” categories and you may be shocked how the discretionary expenses add up.

Two popular software packages that can help you track your spending and saving are Quicken and Quicken is a PC-based software and is web-based. They are both owned by the same parent company, Intuit. is free and automatically collects your transactions from your bank and credit card accounts. It assigns an expense category based on the merchant code that is tracked when you swipe your credit card or debit card. For example, if you swipe your card at Kroger’s it will be classified as groceries and if you fill up your tank at Speedway it will show as gasoline. You can manually edit any entries in and you do have to manually categorize any checks your write and any cash transactions.

Quicken is similar to, but you have to manually download your transactions. Credit card transactions are automatically categorized, just as they are with Quicken has a much wider range of reporting capabilities and more flexibility in choosing historic time periods for reporting. Quicken also has an “Easy Answer” function to answer the questions “How much did I pay to…”  or “How much did I spend on…” for a wide range of time periods that you can select. Quicken also offers bill pay and check writing capability to further simplify your cash management. Different versions of Quicken are available that cost between $60 and $90 before rebates and discounts.

Whether you use manual or software methods to track your income, expenses and savings, the process is enlightening and well worth your effort!


About Bruce J. Berno, CFP®

Bruce J. Berno, CFP® is the founder of Berno Financial Management, Inc. a fee-only comprehensive personal financial planning and investment advisory firm headquartered in Cincinnati, Ohio. Since 1993, Berno Financial Management has been helping individuals and families achieve financial peace of mind. For more information about Berno Financial Management, visit

A “Total Portfolio Approach” and Why It Is Important

Most investors have more than one investment account. They may have an employer’s 401(k), an IRA rollover, a Roth IRA, a joint taxable account and a college 529 plan. Some accounts, such as retirement accounts, all have the same goal, while other accounts, such as a joint taxable account or a college 529 plan, may have different goals. Cash flows, or deposits or withdrawals, from various accounts may be different too. For those with multiple investment accounts, a “Total Portfolio Approach” will help establish an asset allocation as well as an asset location strategy.

  • Asset allocation influences long-term expected returns and volatility.
  • Asset location influences liquidity and income tax efficiency.

For example, an investor may determine that an asset allocation of 70% stocks, 25% bonds and 5% money market funds is ideal for long-term expected returns and volatility.

Does this mean every account will have the same asset allocation? Maybe not. First, the employer 401(k) plan may have a Stable Value Fund, which is attractive but not available in the other accounts. The 401(k) plan may not have a good U.S. small company fund or international fund choice. The Roth IRA may be the last asset to tap into and possibly leave as an inheritance, so more aggressive investments may be appropriate. An investor may need a large cash balance in the joint account to pay for a lump-sum expense within the next year, such as a new car or wedding. The beneficiary of the college 529 plan may be in high school now and the investor doesn’t want to risk a 20% drop in the stock market when the student is a senior in high school.

Implementing the target asset allocation in this case may mean:

  • A higher allocation to bonds in the 401(k) to take advantage of the Stable Value Fund
  • A larger allocation to stocks in the rollover IRA, including U.S. small company or international funds that are better than the 401(k) choices
  • A more aggressive long-term Roth IRA strategy that is more than 75% in stocks
  • More than 5% cash in the joint account to cover the new car or wedding
  • A higher bond or cash allocation in the college 529 plan to minimize stock market risk

Using this asset location strategy will improve liquidity because there will be more money market funds in the joint account and college 529 plan, and it will be possible to withdraw from these for short-term needs.

Asset location can also optimize tax efficiency by having high-income or tax-inefficient investments (such as real estate, commodity or inflation-protected bond funds) in a tax-deferred account such as the IRA rollover or Roth IRA.

Investors should focus on what they can control. Investors cannot control the short-term direction of the stock market or interest rates, but they can control their asset allocation and asset location. A Total Portfolio Approach increases the likelihood that an investor will achieve their personal financial planning goals.


About Bruce J. Berno, CFP®

Bruce J. Berno, CFP® is the founder of Berno Financial Management, Inc. a fee-only comprehensive personal financial planning and investment advisory firm headquartered in Cincinnati, Ohio. Since 1993, Berno Financial Management has been helping individuals and families achieve financial peace of mind. For more information about Berno Financial Management, visit