Guardian IRA

What Is a Guardian IRA?

A guardian IRA is an individual retirement account (IRA) held in the name of a legal guardian or parent on behalf of a child or other minor under the age of 18-21 (depending on state legislation), or an individual who is incapable of handling their own finances due to a physical or mental disability. This is also called a custodial IRA.

Understanding a Guardian IRA

A guardian is responsible for signing documents on behalf of a minor or special-needs adult. The responsibilities of a guardian cease once the child is no longer a minor or when the adult is able to handle their own finances.

There are two different types of IRAs that are suitable for children: traditional and Roth. The primary difference between traditional and Roth IRAs is when you pay taxes on the money contributed to the plan. With a traditional IRA, you pay taxes when you withdraw the money during retirement (at your then-applicable tax rate). A traditional IRA contains pre-tax earnings. With a Roth IRA, the money put into the account has already been taxed, so it contains after-tax earnings.

As the custodian, the adult controls the assets in the custodial IRA until the child reaches age 18 (or 21 in some states), at which point the assets are turned over to them. The IRA is opened in the child’s name and the custodian will have to provide their Social Security number when they open the account.

IRAs make sense for kids who have enough earned income that they would have to file income taxes. Note that for 2020, the standard deduction is up to $12,400 for an individual, and for 2021, it is $12,550. So kids could earn that much and not have to pay any federal taxes, though they would still have to file a return.

Benefits of a Guardian IRA

Like a typical IRA, the money inside a guardian IRA grows tax-free while it’s in either a traditional or Roth IRA. The benefit of a Roth over a traditional IRA is that when the child withdraws the money many decades later, they won't have to pay income tax on it, while a traditional IRA will result in a deferred tax liability. What's more, there are currently no required minimum distributions (RMDs) on Roth accounts. For traditional IRAs, money must be withdrawn once age 72 is reached on an annual basis or 70 1/2 if you reached 70 1/2 before Jan. 1, 2020.

Converting a traditional IRA to a Roth may make sense for kids, especially in years when they have little to no income. They could convert up to the standard deduction each year and pay little to no federal taxes.