My child has a low-paying job, which puts him or her in a marginal tax bracket of 0% or maybe 10%. Isn’t this a good time for them to max out a $6,000 Roth IRA contribution? We are considering a donation to them to partially or possibly fully compensate for their contribution. Do I miss something?
– Marshal
It doesn’t sound like you’re missing anything.
If your child (or you) has the means to contribute something to his or her retirement savings, I would generally recommend a Roth individual retirement account (IRA) as a means of doing so.
Getting the most out of it is of course also nice, but certainly not mandatory. That said, there are always exceptions, and I can think of one or two circumstances where a Roth wouldn’t be ideal. Even those are specific, but let’s look at them just to be sure. (And if you have questions about your personal financial situation, consider working with a financial advisor.)
2 reasons not to let your child finance a Roth IRA
In general, there are a number of reasons why your child may choose not to fund (or max out) a Roth IRA.
Taxes. The biggest reason someone would choose another retirement savings vehicle over a Roth is if they expect to fall into a lower tax bracket in the future. This does not seem to apply in your child’s case, but I will return to it later.
Financial support from the university. A more likely reason why your child may not want Roth is if he is applying for college financial aid through the Free Application for Federal Student Aid (FAFSA). The FAFSA-based award calculation reflects college financial aid in accordance with your family’s financial need.
Lower-income students and parents typically receive more help than their higher-income counterparts. A parent’s income influences the amount of financial support awarded, but the student’s income has a greater impact.
To maximize financial aid for the 2022-2023 school year, the applicant’s income must be less than $7,000. So, in the interest of staying as close to that threshold as possible, you might want to get your child started on the pre-tax contributions of a traditional IRA. The same logic applies to any other situation where they need to minimize reportable income.
Aside from that, I’m having a hard time thinking of good reasons for young people not to save in a Roth.
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Why you should consider a Roth for your child
Roth IRAs are excellent for those who:
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Still a long way from retirement.
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Expect to fall into a higher tax bracket at retirement than they are in now.
Both are almost certainly true for, say, a low-income recent college graduate. So whatever savings your kid can scrape together — even if he’s just waiting and spending most of his paycheck on a downtown studio apartment — is probably worth putting into a Roth.
First of all, their long time horizon means that even a small principal can earn a substantial return once he or she retires. On the other hand, their after-tax contributions will add up to significant savings over the total life of the account, assuming they retire in a higher income bracket than they are now. That’s a reasonable assumption to make.
I would also like to point out that the original question referred to a parental gift to compensate for the child’s contribution. This is a great technique if you can afford it. While the Roth contributions can’t exceed the account holder’s earned income (and only they can contribute in the first place), the IRS doesn’t care if Mom and Dad do their part to ease the strain on his or her living expenses. to light up.
In short
In summary, while there are situations where other investment vehicles might be better, I would say that more often than not a Roth is a fantastic choice for young savers to get an edge. And if they have parents who can and want to contribute, all the better.
Graham Miller, CFP® is a financial planning columnist at SmartAsset, answering questions from readers on personal financial topics. Do you have a question you would like answered? Send an email to [email protected] and your question may be answered in a future column.
Please note that Graham is not a participant in the SmartAdvisor Match platform.
Tips for handling retirement accounts
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Another easy way to save for retirement is by using employer 401(k) matching. SmartAsset’s 401(k) calculator helps you calculate how much you’ll get based on your annual contribution and your employer’s agreements.
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