Ask an Advisor: My Child Works a Low-Paying Job. Is ‘This a Great Time’ for Them to Max Out a Roth IRA?

My child is in a low-paying job that puts them into a 0% or maybe a 10% marginal tax bracket. Isn’t this a great time for them to max out a $6,000 Roth IRA contribution? We are considering a gift to them to partially or perhaps fully offset their contribution. Am I missing anything?

-Marshall

It doesn’t sound like you’re missing anything.

If your child (or you) has the means to contribute anything to his or her retirement savings, I would generally recommend a Roth individual retirement account (IRA) as the vehicle for doing so.

Maxing it out is nice too, of course, but certainly not required. That said, there are always exceptions, and I can think of one or two circumstances in which a Roth would not be ideal. Even those are specific, but let’s take a look at them just in case. (And if you have questions related to your personal financial situation, consider working with a financial advisor.)

2 Reasons Not to Have Your Child Fund a Roth IRA

Generally, there are a couple of reasons why your child may choose not to fund – or max out – a Roth IRA.

Taxes. The biggest 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. This appears to not apply in your child’s case, but I will revisit it later.

College financial aid. A more probable reason why your child might not want a Roth is if they are applying for college financial aid via the Free Application for Federal Student Aid (FAFSA). The FAFSA-based awards calculation tabulates college financial aid in accordance with your family’s financial need.

Students and parents with lower incomes are typically awarded more aid 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.

To maximize financial aid awarded for the 2022-2023 school year, the applying student’s income should be below $7,000. So, in the interest of staying as close to that threshold as possible, you may want to start off your child with the before-tax contributions of a traditional IRA instead. The same logic applies for any other situation where they need to minimize reportable income.

Aside from that, I struggle to think of good reasons for young people not to save in a Roth.

Why You Should Consider a Roth for Your Child

Roth IRAs are an excellent fit for those who:

1. Are still a long way from retirement.
2. Expect to be in a higher tax bracket upon retirement than the one they are currently in.

Both are almost certainly true of a low-income recent graduate, for example. So any savings your kid can scrape together – even if they’re only waiting tables and spending most of their paycheck on a downtown studio apartment – are likely worth putting into a Roth.

For one thing, their long time horizon means that even a small principal can make for substantial returns once they retire. For another, their after-tax contributions will create substantial savings over the total life of the account, assuming they retire in a higher income bracket than they are now. That is a reasonable assumption to make.

Let me also point out how the original question mentioned a parental gift to offset the kid’s contribution. This is a great technique if you can afford it. While Roth contributions cannot exceed the accountholder’s earned income (and only they can make contributions in the first place), the IRS doesn’t care if Mom and Dad pitch in to mitigate any strain on his or her living expenses.

Bottom Line

To sum up: While there are situations in which 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 chip in a bit, so much the better.

Graham Miller, CFP® is a SmartAsset financial planning columnist and answers reader questions on personal finance topics. Got a question you’d like answered? Email AskAnAdvisor@smartasset.com and your question may be answered in a future column.

Please note that Graham is not a participant in the SmartAdvisor Match platform.

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