Open a Roth IRA For Your Children

While many teens had no luck finding a summer job last summer, the fact is that if you would have opened a Roth IRA account for them and contributed as much as possible, and then did the same from the time they were 16 until they turn 21, that small investment would turn into a substantial six-figure sum by the time they reached the age of 65, even if you never made another contribution to it.

There are a few requirements of course. For example, your child needs to have earned income or net earnings from self-employment. Giving money to your children for doing chores around the house doesn’t count, but anything they earned from babysitting, mowing lawns and even a paper route do qualify. This self-employment income should be filed on a tax return for your child even if they don’t have any taxes due, so that you can document the income that they made when you go to contribute to their Roth account. W-2 wages can also be supplemented by self-employment income in order to increase their Roth contribution.

If you yourself are self-employed, you’re allowed to put your children on the payroll in order to generate earned income eligibility for their Roth contribution. Be aware that there are a number of rules that you need to follow if you’re going to employ your dependent children, and check with your tax professional make sure you’re doing it right.

With a Roth IRA you can contribute 100% of the earnings your child makes up to a maximum of $5500 a year in 2014. This amount usually increases by $500 increments each year to keep up with inflation.

One of the best things about opening a Roth IRA is that there is no minimum age are minimum contribution, and there’s also nothing that says that any money deposited in the Roth IRA has to come from their actual earnings. Contributions to your child’s Roth IRA can come from a source like birthday gifts, money they made over the years from working part-time jobs even from their grandparents.

One good thing about Roth IRAs is that, even though there’s no tax deduction, most teenagers don’t actually need it. All qualified distributions from their Roth will be exempt from federal and, most likely, state income taxes as well. That of course assumes that Congress doesn’t change any of the laws about Roth IRAs in the future.

Opening a Roth IRA also encourages your children to not only work but save money. If you want to give them even more incentive, you can match their contributions up to $5500. Even better, since contributions to a Roth IRA aren’t tax-deductible, your son or daughter can withdraw their contributions anytime they like to without taxes or penalties.

There are a couple of caveats however. Firstly, earnings can be taxed and penalized if they are withdrawn prematurely. Also, once the child hits the age of 18, he or she will have full access to all of the money in their Roth IRA and, if they want to, they can take it all out and spend it, which would negate the compounding interest effects that would turn their small investment into that considerable six-figure sum we talked about the beginning of this blog article.

Still, it’s a great way to show them how compound interest works and possibly teach them that saving money isn’t as fruitless as they might think it is.  Good luck!

Leave a Comment

{ 1 trackback }

Previous post:

Next post: