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If you could supercharge your kid’s future with thousands of dollars, would you? We share one investing hack that can make that happen—the Custodial Roth IRA.

Welcome back to #RichGirlRoundup, Money with Katie's weekly segment where Katie and MWK's Executive Producer Henah answer your burning money questions. Each month, we'll put out a call for questions on her Instagram (@moneywithkatie). New episodes every week.

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Audio:

Rich Girl Roundup. Love it.

Katie:

Welcome back, rich people, I guess, I should say rich parents, to the Rich Girl Roundup weekly discussion of The Money with Katie Show. I'm your host, as always, Katie Gatti Tassin, and every Monday my executive producer, Henah, and I are going to talk about something that we think is interesting, topical, controversial, fun. You name it. One of the previous adjectives. Before we do that, here is a quick message from the sponsors of this segment.

All right. Before we get into it this week, this week's upcoming main episode is all about financial freedom and how it actually might be closer than you think. So we're going to dig into the math. We're going to get a little bit nerdy, I would say, with our semantic battle between financial independence, financial freedom. What are the real differences? How are you tracking toward one? Are you already at financial freedom and you may not even realize it? Should you be adjusting your strategy? So that's what's coming this Wednesday. But in the meantime, Henah, how is your flu-ridden body today?

Henah:

The flu is leaving my body very slowly, and I may be having coughing attacks that y'all aren't hearing, but it's okay. We're working on it. I'm very excited about this question from two people who don't have kids.

Katie:

Yeah.

Henah:

This week's question came from Patrick Z. I have a young daughter, and I want to invest for her future. What is the best way to maximize our dollars?

Katie:

The thing that I think would be fun to talk about today... We did an Instagram post about this after the Wall Street Journal wrote about it and kind of got skewered by people being like, "Can't you just let kids be kids?" And I was like, "Yeah, but don't you want your kids to be rich?"

Henah:

True.

Katie:

So I think it's a great opportunity to do a bit of a deep dive on the custodial Roth IRA, if that's cool with you.

Henah:

Sure. So for the uninitiated, including myself, I know what a Roth IRA is, but what is a custodial Roth IRA?

Katie:

So a custodial Roth IRA is basically a Roth IRA for a minor that is controlled and funded, we'll say, with an asterisk because we'll get into that, by an adult until that minor is 18 years old.

Henah:

Okay. So starting them early. I assume similarly to a Roth IRA that you can log in to any financial provider, for example, like Fidelity or Vanguard or whatever, and you can just open an account using your kids' social security number and your own, I don't know, which seems easy enough. So how does it work, and why is it especially great?

Katie:

Well, I should say I haven't obviously opened one of these before, so I don't know exactly what information is going to-

Henah:

You don't have one for Sam or...

Katie:

I don't have one for Sam, although, Georgia, we really could have used one given her health problems. Little Roth IRA for my dog.

Henah:

No, we did use to give them credits in the show so maybe they can claim any show profit is-

Katie:

Are chaos agents. Yeah, that's actually a great idea. I don't know how that works, deductions for paying pets. I guess animals can get paid for things. So anyway, the reason they're great for kids is because kids have the most time ahead of them, which, as we know about compounding, is like the magic ingredient, and so it allows something to grow tax-free for 50 years plus. If someone is getting a Roth IRA when they're 10 years old and they're not going to use it until they're 60 years old, that is an incredibly long time for something to compound. So it's just taking advantage of that.

Henah:

It reminds me of your tweet that was like, "My biggest financial mistake in 2008 was being in eighth grade instead of buying real estate." Yeah, that seems like an incredible time horizon. I know last week, we talked a little bit about a 529 account when we were talking about one of the books. These are similar. What's the difference between a 529 and a custodial Roth IRA?

Katie:

Unless you are a high-income tax bracket individual in a high-income tax state with kids that you're pretty certain are going to go to an expensive school, personally, just-me opinion, not financial advice, I'm not personally a giant fan of 529 accounts. But the primary difference between a 529 and a Roth IRA is that there's just a lot more flexibility with the Roth IRA. Contributions can theoretically be accessed at any time, and they will be able to use it in retirement when most of the account's value is growth, not principal, and because it's Roth, it's tax-free growth. So it's a pretty amazing tool in that sense.

Henah:

I'm definitely taking notes. So is it that you can just throw money into a Roth IRA in their name, or how do we know who's eligible? Because to me, it seems that the IRS must have some tricky times figuring out, is it legal, and has it been set up properly? How does that work?

Katie:

Right. Maybe we should have a beat drop, get Nick on the mixing board again, "Not a tax professional. Please consult your CPA." Basically, the kid has to have earned income whether that's from an actual paycheck job or self-employment. I read online people talking about the kid is babysitting or literally have a lemonade stand or they're mowing lawns or whatever. But there needs to be a record of the labor, and they can only contribute up to what they actually earn up to the regular old Roth IRA contribution limit in 2023, $6,500 per year.

So it's not like a... I'm going to give an example that I think actually is low-key tax fraud, but maybe not. This is probably up to the CPA because this is a-

Henah:

Oh my gosh.

Katie:

... CPA that does this, that I know. He has his baby model for some of his promotional material about families, and then pays her for it, and then puts that money in a Roth IRA. So he's a business owner. So it's like a kid model. I don't know. I've seen some people be like, "That's tax fraud." But is it? I don't know. I really, honestly don't know. So I think it's up to your CPA.

Henah:

Influencers use their babies, and then they'll say, "Oh, I couldn't have gotten this deal without my kids, so the money's going into something for them." I don't know. We're not the IRS. It's not our decision.

Katie:

We're not the IRS. We're also not family YouTube channels. It gets into weird territory really quickly, but the point is the kid has to have earned income of some kind. They need to be working in some capacity, that is a prerequisite for this.

Henah:

Yes. Because I was thinking babysitting or mowing lawns or whatever I used to do as a kid, and it's a hard paper trail, so to speak, unless you literally write down like, "$25 doing blah, blah, blah."

Katie:

That's literally what they recommend doing, at least from what I've read, and again, talk to your accountant. But I read they literally wrote track the date that they're working, what they're earning, who's paying them, have a paper trail, even if you're the one creating it that shows that money has been exchanged for services.

Henah:

So is it then all on the children to fund themselves, or can parents help supercharge it? I've read some matching situations that I want to clarify.

Katie:

I'm just imagining a 7-year-old logging onto their Vanguard account, "All right, time to make my monthly contribution." I know it's a little, little crazy. So let's say your kid, I'll use an example of my own, when I was 15, I was a nanny. I still, to this day, cannot believe that parents entrusted me with their children.

Henah:

I'm surprised by this, also.

Katie:

Yeah. I was a nanny for two doctors. One of them worked days. One worked nights.

Henah:

Doctors.

Katie:

I know. I nannied, I think she was like eight or nine at the time, but it was fun. But anyway, they paid me cash every week, and I was probably making... It was over a summer. I was working like 7:00 AM to 6:00 PM, five days a week. I think I made $500 a week, potentially. I mean, it was unbelievable at the time.

So obviously, I spent that money on Abercrombie. I did not put it in a Roth IRA like I should have. But me at that time, I would've been eligible to contribute up to $6,500. I guess, if it was 500 a week, probably made closer to 2,500 or 3,000 that summer. But what my parents could have done is said, "Okay, you put in half. You're making $3,000, why don't you put in 1,500 of it, and we'll put the other 1,500 in?" So I would've gotten to keep some of my income and spend it on Abercrombie. I also could have saved some of it, and they would've done a, quote, "parental match." So the amount of money that's actually going into the Roth IRA is still limited by the amount I actually earned, but my parents are just putting in the other half. That's what is meant most times by parental match.

Henah:

I see.

Katie:

Not that the parents are putting money in excess of what the kid earned, but it's just a way so that if... And for obvious reasons, most 15-year-olds are probably not earning more than $6,500 a year, and most 15-year-olds probably don't want to put all their earnings into a Roth IRA. So if you're a parent and you're like, "Okay, how can I establish a positive money habit, yada, yada, yada, but also have my kid get to experience some of the fun of having money that they've earned?" It's a nice little middle ground. I would've totally bristled at this as a kid. Now, of course, I'm like, "Oh my God, I'm an idiot." I wish someone would've told me that I could have done this because I truly wasted so much. Probably have another 50K that I'd be sitting on right now had I done this.

Henah:

Probably same. I remember that I worked since I was 14, 15, and I was making $10 an hour, which, at the time, was like god-tier money for a 14-year-old. I really am glad that we're talking about this because I think a big part of it is people just don't know that this is an option.

Katie:

Totally.

Henah:

But when we did talk about it on Instagram, as you alluded to, we got this common question that was like, "Why not just let your kids be kids?" And I very much understand that line of questioning, but did you have any additional thoughts that you wanted to add here of maybe why this isn't a bad thing?

Katie:

Yeah. So I'm not going to sit here and be like, "Well, here's the correct way to parent your children." But I will say, while I do see that argument of like, "Well, let your kids be kids. Why should they have to work at all? Or why would you want them to even be worried about money when they're 10 or 15 years old?" I think my perspective is just that the earlier that a kid establishes positive, healthy money habits and learns about investing and having that be a part of their life from a young age, that's just going to help them turn into a self-sufficient adult that has a healthy relationship with money, and it's going to set them up for a more, I would say, positive and prosperous future. I definitely don't feel like I was robbed of a childhood by having jobs and babysitting and being a nanny, but I do think that there's something... I mean, work is a part of life, and I think the earlier that you can frame those habits as a good thing and a positive thing, the better.

How long is that money going to compound? Even if you just maxed it out one year, $6,500 left alone from age 15 to 65 will be worth almost 200 grand, if you assume they're getting just 7% rate of return on average. So that means for every dollar they put in, they retire with a tax-free $30. To me, that's just like, what an amazing way to teach your kids from a young age. And again, I think that that was the tone of the response was like, "Why would you want to stress your kids out about this?" But that's where I would push back and go, "I don't know that it has to be stressful." I think it can be a really cool learning opportunity because investing is amazing. It's a great way to grow wealth and to feel financially free, and how cool to be graduating from high school or college and to be like, "Oh, yeah, I already have tens of thousands of dollars for retirement."

I feel like I can really take my time getting set up now in the working world because I've got savings already and I understand how to manage my money. To me, I have a hard time seeing why that's bad, at least in the current paradigm we exist in. As long as you have to work for income, it's good to know how to do that and have some experience.

Henah:

Within the world of capitalism, I feel like you're really setting yourself up for success with a gift that pays off in spades.

Katie:

And, I will add, it's probably going to be tax-free straight through because most kids are not going to be earning enough money to where they would have money above and beyond the standard deduction. So if they likely are not going to pay tax on the money as they're earning it, it's going to go in tax-free and grow tax-free and come out tax-free. So a straight-up untaxed 200K, it's all in the framing. And if you're stressed about money, they're probably going to feel that if that's how it's presented to them. But I think it's about how it's framed and presented, and it's just about like, "Look, you are able to do this for yourself. Look at your hard work and how that's paying off."

Henah:

I'm trying to make the mental note for myself to come back in 12 years and be like, "Hmm, when future Henah's child starts working, this is the thing you need to keep in mind."

Katie:

I know. I'm like, "Don't come for me, parents. If I'm totally wrong, let me sit here in my naïveté and wrongness." But I don't know. I am just functioning for my own like, what I wish. I wish this would've been something that I had known about. I wish that this had been an option.

Henah:

Doing the math that you just said, the 6,500 turning into almost 200 grand, I'm like, "Oh, I could have been 200 grand closer to retirement is a pretty wild thing to recognize."

Katie:

Right? It's nuts. That's so much money. And in today's purchasing power, that's like I'm using that inflation discounted annual rate of return. So it's more in nominal terms, but it'd be like an extra 200K today. It's not insignificant.

All right. Well, that is all for this week's Rich Girl Roundup. We will see you on Wednesday to continue this discussion of financial freedom.

Henah:

For adults. Bye.

Katie:

For adults this time. Bye.

Henah:

Bye.