What are the Disadvantages of a Custodial Roth IRA?

A custodial Roth IRA can be a powerful way to help children start saving early and learn about investing. While the long-term tax benefits can be significant, there are also important limitations and considerations parents should understand before opening one.

Contribution Limits and Earned Income Rules

Custodial Roth IRA contributions are limited by two factors: the annual IRS limit and the child’s earned income. For 2026, the maximum contribution is $7,500 (adjusted for inflation in future years), but a child can only contribute up to what they actually earn. Earned income must come from legitimate sources like W-2 wages or documented self-employment, not gifts or allowances. For example, if a child earns $4,000 in a year, that is the maximum they can contribute, even if the IRS limit is higher.

How Parents Often Fund the Account

Many parents choose to gift money into the custodial Roth IRA up to the amount their child earned. This allows the child to keep their paycheck for spending while still benefiting from long-term investing. However, if a child is employed through a family business, the IRS may scrutinize this closely. It’s essential that the work is legitimate, properly documented, and reasonably compensated.

Loss of Parental Control at Adulthood

Because this is a custodial account, ownership automatically transfers to the child at the age of majority, usually 21, though some states use 18. At that point, the child has full control of the account, regardless of maturity or financial responsibility. Contributions are also considered a completed gift, meaning once the money is in the account, it cannot be taken back.

Withdrawal Rules and Limited Flexibility

Custodial Roth IRAs follow the same rules as adult Roth IRAs. Contributions can be withdrawn at any time, but withdrawing earnings before age 59½ may result in income taxes and a 10% penalty. Because of this, these accounts are best suited for retirement savings, not education or short-term goals. If flexibility is a priority, a traditional custodial brokerage account may be a better fit.

Impact on Financial Aid (FAFSA)

Assets held in a child’s name can negatively impact FAFSA calculations. Custodial accounts are counted more heavily than parent-owned assets, which could reduce eligibility for financial aid, grants, or subsidized loans. While this shouldn’t automatically rule out a custodial Roth IRA, it’s an important planning consideration.

Custodial Roth IRAs can be an excellent long-term tool for teaching children about retirement planning and tax-free growth. However, the funds are relatively locked up, ownership eventually transfers to the child, and there may be financial aid implications. If the goal is education funding or flexible investing, other vehicles may be more appropriate. As with most planning strategies, the right choice depends on your goals and your child’s situation. Schedule a complimentary consultation and discover how our services can help you achieve financial freedom.