My child is in a low-paying job that puts them in a 0% or maybe 10% marginal tax bracket. Isn’t this the perfect time for them to max out a Roth IRA contribution of $6,000? We are considering giving them a gift to partially or perhaps fully offset their contribution. Am I missing something?
It doesn’t look like you’re missing anything.
If your child (or you) can afford to contribute anything to their retirement savings, I would generally recommend a Roth Individual Retirement Account (IRA) as a way to do so.
Maximizing it is fine too, of course, but certainly not mandatory. That said, there are always exceptions, and I can think of a couple of circumstances where a Roth wouldn’t be ideal. Even these are specific, but let’s take a look just in case. (And if you have questions about your personal financial situation, consider working with a financial advisor.)
2 reasons not to ask your child to fund a Roth IRA
Typically, there are several reasons why your child may choose not to fund — or maximize — a Roth IRA.
Taxes. The main reason someone might choose another retirement savings vehicle over a Roth is if they expect to be in a lower tax bracket in the future. That doesn’t seem to apply in your child’s case, but I’ll get to that later.
College financial aid. A more likely reason your child might not want a Roth is if they apply for college financial aid through the Free Federal Student Aid Application (FAFSA). The FAFSA-Based Awards Calculator calculates college financial aid based on your family’s financial need.
Low-income students and parents generally receive more help than their higher-income counterparts. A parent’s income affects the amount of financial aid awarded, but the student’s income has a greater impact.
In order to maximize the financial aid granted for the 2022-2023 school year, the student 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 start your child off with pre-tax contributions from a traditional IRA instead. The same logic applies to any other situation where they have to minimize the income to report.
Other than that, I’m struggling to find good reasons for young people not to save in a Roth.
Why you should consider a Roth for your child
Roth IRAs are ideal for those who:
Are still far from retirement.
Expect to be in a higher tax bracket in retirement than they are now.
Both are almost certainly true for a low-income recent graduate, for example. So any savings your child can muster — even if it’s just waiting tables and spending most of their salary in a downtown studio — are probably worth investing in. a Roth.
On the one hand, their long-term horizon means that even a small manager can generate substantial returns once retired. On the other hand, their after-tax contributions will create substantial savings over the lifetime of the account, assuming they retire in a higher income bracket than they currently are. This is a reasonable assumption to make.
Let me also point out how the original question mentioned a parental gift to offset the child’s contribution. It’s a great technique if you can afford it. While Roth’s contributions can’t exceed the account holder’s earned income (and only he can make contributions in the first place), the IRS doesn’t care if Mom and Dad step in to ease any strain on his living expenses.
To sum up: while there are situations where other investment vehicles may be better, I would say that more often than not a Roth is a fantastic choice for young savers to get a head start. And if they have parents who are able and willing to contribute a little, so much the better.
Graham Miller, CFP® is a SmartAsset financial planning columnist and answers readers’ questions on personal finance topics. Do you have a question you would like answered? Email AskAnAdvisor@smartasset.com and your question might be answered in a future column.
Please note that Graham does not participate in the SmartAdvisor Match platform.
Tips for Managing Retirement Accounts
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