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5 Reasons to Consider Giving the Gift of a Roth IRA

When it comes to giving thoughtful gifts, financial security may not be the first thing on your mind. However, gifting a Roth IRA can be a meaningful way to start your loved ones on a path toward financial security.

As a reminder, a Roth IRA is a type of individual retirement account that offers tax-exempt growth and tax-exempt withdrawals in retirement, which make it a powerful tool for building long-term wealth. Contributions to Roth IRAs are made with after-tax dollars, and qualified withdrawals of assets are tax-exempt and don’t increase your taxable income. In contrast to traditional IRAs, Roth accounts aren’t subject to required minimum distributions (RMDs) during the owner’s lifetime, which means assets in the account can continue growing tax-exempt throughout the account holder’s life.

There are several benefits to gifting a Roth IRA.

#1 – Tax-Exempt Growth

One of the primary benefits of Roth IRAs is that they allow contributions to grow on a tax-exempt basis. This means any earnings, such as interest, dividends and capital gains, aren’t subject to federal income taxes while held within the account. Over time, this growth can add up to significant savings, especially for younger investors who are able to let their assets grow over many years before withdrawing them in retirement.

#2 – Retirement Savings

Establishing a Roth IRA for a loved one can be a great way to help them save for retirement. Many young people struggle to find extra money to set aside each month for retirement planning. Funding a Roth IRA can help remove some of that financial burden and allow your family member to focus on other financial priorities, such as saving for a home, paying down student loan debt, starting a business, etc.

#3 – Financial Literacy

Giving a Roth IRA can be a great opportunity to educate your loved ones on multiple financial topics, such as the importance of saving early and often, the power of compound interest, the basics of investing and the importance of planning for one’s retirement. By gifting a Roth IRA, not only are you helping your loved ones financially, you’re also teaching them important financial strategies that can benefit them for a lifetime.

#4 – Estate Planning

Not only are Roth IRAs not subject to RMDs during the account holder’s lifetime but they can also be passed on to heirs tax-free following the account holder’s death. Roth IRAs are a tax-efficient way to transfer wealth to future generations, because they allow heirs to receive assets without having to pay income taxes on the distributions (unless the Roth IRA is less than five years old).

In addition, Roth IRAs don’t count toward the taxable estate of the account holder, which means they can help reduce the size of an estate for tax purposes. By gifting a Roth IRA as part of an estate planning strategy, the account holder has the potential reduce his or her heir’s estate tax liability, which ultimately helps preserve more assets for future generations.

#5 – Compound Interest

By gifting a Roth IRA to a younger family member, you offer the opportunity to take advantage of compounding interest over the individual’s lifetime. The impact of this benefit cannot be overstated.

For example, suppose you contribute $1,000 to a Roth IRA on behalf of your granddaughter every year, beginning when she is 20 years old. By the time your granddaughter reaches age 40, you would have invested $20,000 on her behalf ($1,000 x 20 years). Assuming an average annual return of 10%, the investment would be worth $63,773.40 after 20 years.1

On the other hand, if your granddaughter began contributing $2,000 per year to a Roth IRA from age 30 to 40 ($20,000 total), her investment would only be worth $36,934.83 after 10 years (again assuming an annual average return of 10%), because she has less time to take advantage of the power of compounding.2

As you can see, gifting a Roth IRA to young family members has the potential to significantly improve their long-term financial outlook. It’s important to note that gifting to Roth IRAs should not exceed the amount actually earned in a year by the account owner — or the maximum contribution limit, if the owner earns more than that amount. If you’re interested in learning more about gifting a Roth IRA, Creative Planning is here for you. Our experienced teams take time to get to know you, your current financial situation, your goals for the future and any challenges you may face before offering well-informed, custom solutions to meet your needs. For more information, please schedule a call with a member of our team.

This commentary is provided for general information purposes only, should not be construed as investment, tax or legal advice, and does not constitute an attorney/client relationship. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed.


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