No matter who you ask about retirement accounts, the answer is always the same: start investing as early as possible. Thanks to the power of compound interest, the sooner you invest in a retirement account, the more time there is for growth. But for those under the age of 18, opening an individual retirement account (IRA) isn’t possible. That is unless it is done through a custodian (parent or guardian) to manage the account.
A custodial IRA may be the best option for those interested in getting a head start on saving for retirement from a young age.
What is a Custodial IRA?
A custodial IRA is a retirement account held in the name of a minor and managed by a custodian. Because minors aren’t allowed to open IRA accounts themselves, they need a custodian to open an account for them. Within the IRA account, the custodian manages all assets until the child becomes 18, after which they can take complete control of their custodial IRA account.
A custodial IRA must be opened by a parent or guardian of the minor on the account. However, anyone — including grandparents, other family members, and family friends — can contribute to the IRA via a gift if desired.
When the minor turns 18, they gain full ownership and custody of their retirement account. This means they can then manage all of the assets and investments within their IRA directly.
Custodial Roth vs. Traditional IRA
Custodial IRAs come in both Traditional IRA and Roth IRA account types. When it comes to children, a Roth account is usually considered the best way to go. In a Roth IRA, money is contributed after-tax, and all earnings grow tax-free.
This is an alternative to a Traditional IRA in which contributions are made pre-tax, and taxes are paid on withdrawals at the time of withdrawal during retirement. Also, a Traditional IRA includes required minimum distributions (RMDs) to be taken in retirement over the account holder’s life, while a Roth IRA does not. So if you want to gift a minor with tax-free funds, a Roth is the smart choice.
Withdrawals
Generally, custodial IRAs come with the same withdrawal limitations as their Roth and Traditional IRA counterparts. However, there is one important caveat. If contributions to a custodial IRA are withdrawn to fund higher education expenses, they are penalty-free, regardless of when they were withdrawn. The same goes for a first-time home purchase (with some additional qualifications).
Early withdrawals that aren’t for one of these qualifying reasons are subject to a 10% early withdrawal tax. However, any contributions to a Roth IRA can be withdrawn penalty-free since these funds have already been taxed when contributed to the account– but you have to wait five years first. For example, let’s say you contributed $3,000 to your Roth IRA in 2015, and it grew to $5,000 by 2020. You can withdraw this contribution ($3,000) in 2020 (5 years later) without paying any early withdrawal penalties, but if you withdrew the remaining $2,000 it grew, you would be penalized.
Gold in a Custodial IRA
When thinking about investment options in a custodial IRA, gold is something to consider. Think about this: an IRA account opened for someone who is 15 will likely be open and growing for the next 50 years! In that time, the world will look much different. It is almost impossible to predict what will happen with asset prices over a long period of time. How many companies have failed in the last 50 years? How many companies and nations have defaulted on debt payments? How many economic crises have there been, leaving destitution in their wake?
In comparison, gold is a precious metal that has retained its value for decades and is likely to continue to do so.
A Gold IRA might be an excellent option for those that want a sound, solid investment for a minor to hold its value no matter what the future brings.
Contribution Limit
Like other IRA accounts, Custodial IRAs not only have a set maximum contribution but contributions are also limited based on income. The contribution made to a custodial IRA is limited by the income earned by the minor during that year.
For instance, if the minor earned $2,000 through their job as a dishwasher during the year, then $2,000 becomes the maximum that can be contributed to their custodial IRA in that year. But if the minor did not earn any income, no contributions can be made to their custodial IRA in that year.
Regardless, the maximum contribution for a custodial IRA is currently $7,000 for the 2024 tax year. You can view 2023 contribution limits here.
While the custodian may make contributions to the IRA, others can also contribute to the retirement account as well if desired through a gift (but still not more than the income the minor earned that year).
How to Open a Custodial IRA
Opening a custodial IRA shouldn’t be much different than opening your own retirement account. You will need the personal information of whoever is opening the account and acting as the custodian, as well as the information of the minor for who the account is intended. Some brokers may require you to make a minimum deposit when opening a custodial IRA. However, this deposit amount (if any) will typically be lower than opening a different type of IRA.
Investment Options
Much like other tax-advantaged retirement accounts, a custodial IRA is open to a wide variety of assets. As previously mentioned, gold and other precious metals make great additions to a custodial IRA. They are solid store-of-value assets that hold their value no matter the economic conditions. These accounts also allow for almost any type of investment option that is available for other IRA accounts. Precious metals also act as exceptional diversifiers.
Custodial IRAs are available at most major brokers and financial institutions, where you might open a standard IRA account. This includes (but isn’t limited to): TD Ameritrade, ETrade, Fidelity, and Charles Schwab.
Recap
- A custodial IRA can be opened for a minor (under age 18) and managed by a “custodian” (parent or guardian)
- Both Roth and Traditional IRA are available options for custodial IRA
- Roth IRAs are usually recommended for their tax-free growth
- Early withdrawals are penalty-free if used for higher education or first-time home purchase
- Contributions are limited to the maximum income earned by the minor in a given year
- Family and friends can contribute to the custodial IRA as well
- A custodial IRA can be opened at any major brokerage
