Getting your children started with an individual retirement arrangement, or IRA, helps them learn the value of saving while taking advantage of tax-free growth. The Internal Revenue Service does not set a minimum age to contribute to an IRA, but the child needs to have some form of compensation as well as a Social Security number or other tax identification number. For example, if a 10-year-old has a cookie stand and makes a profit, that counts as compensation. Usually, IRAs are in the name of owner, but some financial institutions let you create a custodial IRA. This allows you to maintain oversight of the account until the child reaches the age of majority -- usually 18 or 21, depending on the state. Anyone can give a child money and help her set up an IRA account in his her name. According to Kiplinger, some financial institutions offer low or no minimums for contributions. However, the amount you contribute is limited by the amount the child actually earns during the year -- any more is considered an excess contribution, which can be hit with severe penalties.
Calculate your child's compensation for the year. Compensation is income from working. Wages and self-employment income qualify, but gifts, inheritances and investment income do not. Compensation matters because without it, the child can't have contributions made to an IRA. Also, if the child's compensation is lower than the annual contribution limit, contributions are limited to the child's compensation. As of 2012, the annual limit is $5,000, rising to $5,500 in 2013. For example, if the child worked over the summer and earned $2,250, you could contribute as much as $2,250 to his IRA.Step 2
Help your child open an IRA in the child's name at the bank of your choice. The child will have to fill out an application, including her name, address, Social Security number, date of birth and country of citizenship. If you're starting a custodial IRA, you'll also have to provide the same information about yourself. Depending on the state, you might also need to make note of when the child can take full control of the account. Applications can be submitted in paper form or online, depending on the financial institution. If you're creating a custodial account, you must sign the form. If it's in the child's name, the child needs to sign. The application is signed under penalty of perjury, so you won't have to submit copies of identification.Step 3
Contribute up to the smaller of your child's compensation for the year or the annual contribution limit. If he earned $7,000, you can still only contribute a maximum of $5,000. There isn't a one-size-fits-all formula for how much a child should contribute. As a general rule, however, the child should be encouraged to contribute as much as he can to take advantage of the the IRA's tax-free growth. If you show the child how the money can grow, it might motivate him to maximize his contributions.
- If the child puts money in an IRA without compensation, she is making an excess contribution. This results in a 6 percent tax penalty each year until the excess is corrected.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."