Investment education, tax-free retirement funding, and estate planning probably won’t spring to mind when selecting the perfect gift. However, giving a Roth IRA to a loved one may be one of the most considerate gifts to consider, especially since it’s a gift that keeps giving year after year. The Roth IRA is an individual retirement account that offers the significant advantages of tax-free growth and qualified tax-free withdrawals. While Roth IRA contributions are made on an after-tax basis and do not provide a tax deduction in the year of contribution, there is no requirement to take a distribution from the account during the account owner’s lifetime. As there are no required distributions from a Roth IRA, money invested and not needed for living expenses grows tax-free and is eventually left to heirs who enjoy qualified tax-free withdrawals as well.
A teenage family member who is babysitting or completing odd summer jobs may provide a great gifting opportunity, since any teenager with taxable earned income from a job or from self-employment is eligible to contribute to a Roth IRA. The annual Roth IRA contribution limit is $7,000 in 2025 for those under age 50 or actual earned income if less. For instance, a minor who earned $2,500 during the year is not eligible to contribute more than $2,500 to a Roth IRA. If the minor earned $10,000 during the year, they are limited to a $7,000 annual Roth contribution. If the minor’s parent gifts the sum to fund the Roth IRA, the gift is not considered earned income. Since younger investors are likely to have lower taxable income, the loss of a tax deduction by choosing Roth over regular IRA is probably inconsequential.
Many IRA custodians, including Schwab, offer custodial Roth IRAs for minors where the minor is considered the account owner, while the custodian has the authority to trade, invest, request a withdrawal, or close the account on behalf of the minor. A parent or other relative can set up the Roth IRA for the minor and contribute to the account on the minor’s behalf. The minor will assume full control of the Roth IRA upon reaching the legal age of majority (18 or 21 as determined by their State) at which time they will have full access to the account and the ability to make withdrawals. A parent or family member cannot open a Roth IRA on behalf of an adult child, but can gift an adult child the money used to contribute to the Roth IRA. Any gift under the annual gift tax exclusion of $19,000 in 2025 is not subject to gift tax or gift tax reporting.
Contributing to a Roth IRA on behalf of a young gift recipient may provide valuable investment education at a critical time in life while encouraging the lifelong habit of saving and investing on a regular basis. Gifting a Roth IRA to a young gift recipient also reinforces the benefits of tax-free growth and the importance of planning for their own retirement. In addition, gifting a Roth IRA provides a great opportunity to determine an appropriate investment strategy, understand how the contributions and earnings in the Roth are invested and why.
Younger investors who do not need the Roth IRA funds will get a valuable and early start on retirement by letting their Roth investments grow for decades. This will likely improve their chance for financial security, especially for younger investors who may have a difficult time saving for retirement. As an example of the power of time, a 15-year-old who invested $7,000 per year in a Roth IRA earning only 4% per year would have an estimated $1,068,669 by age 65. In contrast, a 30-year-old who invested $7,000 per year in a Roth IRA, earning only 4% per year, would have an estimated $515,566 by age 65.
Qualified withdrawals from a Roth IRA are free from income tax and penalties. To be qualified, withdrawals of earnings must have been left in the account for at least five years, and the taxpayer must be age 59 1/2 at the time of withdrawal. Gifting a Roth IRA to a young investor will enable them to start the clock ticking on meeting the five-year rule for qualified tax-free withdrawals. Distributions from a Roth IRA must be distinguished between contributions and earnings. Roth contributions can be distributed back without taxes and penalties at any time. However, distributions of earnings, created from interest, dividends and investment appreciation on the contributions, must be qualified to avoid income tax and penalties. In addition, for withdrawals before the age of 59 ½ that include up to $10,000 for the purchase of a first-time home or for qualified higher education expenses, Roth IRA earnings are free of the 10% penalty but may be subject to income tax.
Please give us a call if you would like to discuss the benefits of gifting a Roth IRA to a valued family member in your life.
