My son is in a low paying job that puts him in the 0% or maybe 10% marginal tax bracket. Wouldn’t this be a good time for them to max out their $6,000 Roth IRA contribution? We consider gifts for them to partially or perhaps fully compensate for their contribution. Am I missing anything?
It’s not like you’re missing anything.
If your child (or you) has the money to contribute anything to their retirement savings, I generally recommend Roth individual retirement account (IRA) as a vehicle to do so.
Maximizing it is nice too, of course, but definitely not necessary. That said, there are always exceptions, and I can think of one or two situations where a Roth isn’t ideal. Although it is special, but let’s see just in case. (And if you have questions related to your personal finances, consider working with a financial advisor.)
2 Reasons Not to Fund Your Child’s Roth IRA
In general, there are several reasons why your child may choose not to fund — or max out — a Roth IRA.
Tax. The biggest reason someone may choose another retirement savings vehicle over a Roth is if they expect to be in a lower tax bracket in the future. This probably doesn’t apply in your child’s case, but I’ll get back to that later.
College financial aid. A more likely reason why your child may not want a Roth is if they are applying for college financial aid through it Free Application for Federal Student Aid (FAFSA). The FAFSA-based award calculation tabulates college financial aid according to your family’s financial needs.
Low-income students and parents are typically awarded more aid than their higher-income counterparts. Parental income affects the amount of financial aid awarded, but student income has a greater impact.
To maximize financial aid awarded for the 2022-2023 school year, the applicant’s income must be below $7,000. So, in the interest of staying as close as possible to that threshold, you may want to start your child off with pre-tax contributions from a traditional IRA instead. The same logic applies to other situations where they need to minimize their reportable income.
Besides, I struggle to think of a good reason for young people not to save in a Roth.
Why You Should Consider a Roth for Your Child
Roth IRAs are ideal for people who:
Still far from retirement.
Expect to be in a higher tax bracket when retiring than the one they are currently in.
Both are almost certainly true for low-income recent graduates, for example. So whatever savings your kids manage to put together — even if they just wait tables and spend most of their paychecks in a downtown studio apartment — probably deserve to be put into a Roth.
For one thing, their long horizon means that even a small principal can make for big returns once they retire. For others, their after-tax contributions will create significant savings over the total life of the account, assuming they retire in a higher income bracket than they currently do. That is a reasonable assumption.
Let me also point out how the original question is said a parents gift to compensate for the child’s contribution. This is a great technique if you can afford it. While the Roth contribution cannot exceed the income of the accountholder’s earner (and only they can make the contribution in the first place), the IRS does not care if Mom and Dad pitch to reduce all the strain on their living expenses.
To summarize: While there are situations where other investment vehicles are better, I would say that, more often than not, the Roth is a good choice for young people to start with. And if they have parents who can and are willing to chip in bits, so much the better.
Graham Miller, CFP® is SmartAsset’s financial planning columnist and answers reader questions on personal finance topics. Do you have a question you would like answered? Email [email protected] and your questions may be answered in future columns.
Please note that Graham is not a participant in the SmartAdvisor Match platform.
Tips for managing retirement accounts
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