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This might be a foolish idea, and if it is please tell me why.

Last night I got the idea that it might be a good idea to invest the money that I'm saving for my children in a Roth IRA in their name. The basic idea is that I would trade the ability to pay more of my children's college expenses for a secure/improved retirement for them.

The details are as follows:

I would put $250 a month into each child's Roth IRA for the next ~15 years. That would give us $45k in principle that I've paid into each Roth IRA. I believe that we/they could pull out that $45k for college expenses tax and penalty free. In addition there would be ~$60k in the Roth IRA in the form of capital gains. Assuming the child never added a dime to the Roth IRA for the rest of their life then they would have somewhere between $700k to $2,500k at the age of 60 when they can take the money out tax free. While $45k isn't going to cover all their college expenses it will certainly help them get through college. Then when they retire I've also given them a large boost effectively for free due to 40 years of compounding interest. As such it feels like I'm killing two birds with one stone.

What worries me is I'm not incredibly financially clever, and I've never heard of anyone doing this and/or recommending this path. Since there are lots of very smart people thinking hard about this problem, and I don't see people talking about this...


This question feels very similar to me but it looks like they're talking about using their retirement account instead of a Roth IRA in their children's name. I don't know if that materially changes the answer but it feels very different to me because they aren't directly contributing to their children's retirement fund.

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up vote 15 down vote accepted

One problem with this plan is that the individual must have earned income to contribute to a Roth IRA. If you have an infant, unless she is the new Gerber baby or something like that, there is probably no legitimate way for her to earn income.

If you own a business and have kids who are older, you can employ them to do work for you, but they must really do work and earn around the market rate for that work. Otherwise, it is unlikely that they will be able to earn enough to fund an IRA until they are teenagers.

When they are old enough to work, you can "match" their earnings by contributing the same amount to a Roth IRA on their behalf, but this will not give you the amount of contributions and growth time that you were counting on.

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You will have to file their tax returns to prove their income. Do you think the IRS is going to accept that toddlers are earning $250/month? – Aravis Feb 10 at 18:50
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@Erik seems like you have your answer already, but aren't happy with it. No, you cannot open an IRA for a toddler and have the IRS think everything is OK. Go open a standard savings account, college savings plan, or managed brokerage account and invest in it. – SnakeDoc Feb 10 at 19:55
    
@Erik nothing wrong with that practice :) It just looked like you were fishing until someone said what you wanted to hear... – SnakeDoc Feb 10 at 19:59
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@SnakeDoc While I would have preferred to be a genius that discovered a fantastic loophole, I've come to terms with the fact that I'm just an average guy who had an idea that isn't legal. Which at the end of the day means I gained one wisdom point. :) – Erik Feb 10 at 20:04
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+1 for your last paragraph. It's not implausible that someone could get a part-time job starting at age 14 and work enough to earn $250 a month. If you matched this with Roth contributions, that would give them ~$12,000 in contributions by the time they're headed off to college. That's unlikely to pay for their education, but could be a useful emergency fund, and also is a great early start on retirement savings that will be compounding throughout the kid's life. – BrenBarn Feb 10 at 20:09

The problem with this plan is that in order for your children to put money in their own IRA, they need earned income of their own. If your child doesn't have $3000 in earned income for the year, you won't be able to put the $3000 into their Roth IRA.

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@Erik No, I don't think so. Are you going to give them a job as an employee and pay Social Security taxes? Are you going to issue them a 1099 as an independent contractor? Not a good idea, unless you have an actual job for them and pay them real wages. You can certainly give them a $250 gift, but it will not be considered earned income for IRA eligibility. – Ben Miller Feb 10 at 18:45

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