Charles Schwab Custodial IRA Account for Minors
Children are the future, and an investment in that future now is the best investment you can make. And one of the best ways to do that is to create a tax-advantaged retirement account for your children today. We’re talking about IRAs for minors.
Why open a Charles Schwab IRA account for a minor? Here are a few reasons:
Compounding Gains
Compounding interest is one of the most powerful and underappreciated financial tools, but there’s a catch. Compounding interest works best when there’s a ton of time available for the money to grow. Let’s look at a quick example using the most straightforward financial instrument to consider compounding – certificates of deposit (CD). Luckily, Charles Schwab offers certificates of deposit so that we can buy them through our IRA.
It looks like the JP Morgan Chase Bank 5-year CD offers the best coupon (interest rate), so we’ll choose that one.
With this, our interest is paid twice a year (semi-annually) and is 5% of each CD valued at $1,000 – so, $50 on the CD’s principle. We’ll assume that you’re maxing out the IRA at $6,000 yearly but not making any additional deposits between now and when the CD expires (5 years).
Your current investment could be worth as much as $7,680.51.
Compounding interest earned 28% on this investment in just five years, without additional contributions, and a CD is a very safe, low-yielding asset. Money invested in riskier vehicles like stocks tends to grow much more over a long period. Just look at the growth of $10,000 in the S&P500 over the past ten years. Even with the recent downturn, the long-term return is significant:
Hopefully, this simple example shows why investing early in our children is best. The longer the money has to grow, the better. But why an IRA instead of, say, a traditional personal brokerage?
Tax Advantages
Just because your child isn’t earning enough income to be in a high tax bracket doesn’t mean they won’t be in the future. Since you can’t start withdrawing an IRA before retirement, they will almost certainly be in a higher bracket than they are now.
When you deposit money into a Roth IRA (usually seen as the better alternative for children), you’re depositing money after taxes. So, while the money grows tax-free in the account, your child can skip paying income taxes when it’s time to withdraw. Some retirement accounts have minimum distributions at a certain age, but not Roth IRAs.
Why is this? Since your child is in a low tax bracket now, with little relative income, they will be able to withdraw that money at the same bracket when it’s time to do so despite likely being in a higher bracket. It’s complicated, and the rules may change over time, but even the experts agree that a Roth IRA is the best option for minors.
There’s another catch, however. Since minors can’t legally represent themselves financially, it must be a custodial account.
Charles Schwab Custodial IRA Accounts
Simply put, a custodial minor account is in the minor’s name but has a designated custodian to manage the account until the minor is of legal age. Charles Schwab lists some basic information and limitations before you open an account to ensure you understand the process:
Eligibility Requirements for Charles Schwab Custodial IRA
Traditional and Roth IRAs require Minor IRA participants to earn income to make contributions. Earned income cannot include gifts or inheritances. The work can be for other people, such as neighbors or for your own business.
Contribution Limits
Children, parents, and grandparents can contribute to a Minor IRA. Contribution limits are capped at the child's or grandchild's earned income for a particular year or at the IRA contribution limit for that year, whichever is less.
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Establishing the Charles Schwab Custodial IRA
Establishing an IRA for a minor is as easy as establishing a regular IRA. The IRA must be in the minor's name as well as the custodian's name, and it must use the minor's tax ID number.
Once you understand this and do any additional necessary research, it’s easy to start. If you’re an existing account holder, you’re directed to a page to open a new account under your main account. We’ll select Minor Roth IRA.
Since a minor account is somewhat complicated, you can’t apply online. But Charles Schwab will help you pre-fill information to email or mail to get the ball rolling on your custodial IRA account.
Once you enter this information, you’ll also need to complete the following:
1. An application for a Minor Individual Retirement Account
2. A deposit slip (optional) to initially fund the account from an external bank.
3. Transfer form (optional) if you’re transferring to Charles Schwab from an existing account.
These forms are long, but we’ll look at snapshots to get an idea of how complicated they are:
You’ll also need to review and understand some legal documents associated with the account, like:
1. Client Relationship Summary
2. Roth Individual Retirement Custodial Account Agreement
3. Commissions and Fees
4. Charles Schwab Privacy Statement
5. Client Agreement
6. Summary of Cash Sweep Program
There are too many to include pictures of all these, but rest assured they’re essential. If you’re confused by the information in any of them, it may be best to contact Charles Schwab customer service or consult a lawyer/financial professional.
Once done, you’ll fax, mail, or email the forms to Charles Schwab.
A little more complicated than a standard adult IRA or brokerage account, but not too terrible. And it’s worth a little extra time and effort to set your children up for success as adults. Not only that, but this is an excellent opportunity to teach your children financial literacy, the power of compound interest, and the basics of investing – all topics that will set your child up to be a well-rounded, financially healthy, and happy adult.
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