“Setting Your Children up for Retirement”

For many people, setting their child up for success in the future is one of their responsibilities as a parent or guardian.  Setting them up for success comes in many different facets (think life skills, hard-work, manners, etc..), but we will be focusing on the financial aspect today. This responsibility doesn’t necessarily require you to save money for their future, but it certainly helps them to get started on the right foot. One of the best ways a parent can do this is by setting up a retirement account on their behalf. This retirement account, a Minor Roth IRA, is the investing loophole that will set your child up for retirement because compounding interest has more time to work. However, there are many factors to consider when determining if you are eligible to contribute to an IRA on your child’s behalf.   First, What is a Minor Roth IRA? An IRA is an individual retirement account. It enables you to save for retirement outside of an employer-sponsored plan.  A Roth IRA designates how your money is invested for tax purposes. For this type of an account, you contribute post-tax dollars.  As soon as your child has earned income, you can open a Minor Roth IRA on their behalf. The money invested in this account will grow tax-free until your child reaches retirement age. This means that they will be able to withdraw the money from the account without paying taxes or penalties on the earnings – as long as they are at least 59-1/2 years old and have held the Roth IRA for five years.  Contributions to the account can always be withdrawn tax and penalty free. However, if they need to withdraw earnings before their age and time requirements have been met, they will pay ordinary income taxes and a 10% penalty on the earnings. There can be exceptions to the penalty if they are using the funds toward education, health care expenses, or a first-time home purchase.   What are the Contribution Limits? You will have a maximum amount that you can put into your Roth IRA or your child’s Roth IRA for every tax year. The IRS announces if there will be an increased contribution limit for the following tax year each year.  For 2020, an individual under the age of 50 can contribute up to a maximum of $6,000, while an individual aged 50 or older can contribute up to a maximum of $7,000. Your contribution will need to be either the amount of the limit or the amount of your earned income, whichever is lower. Example: You must earn at least as much as you contribute to your IRA. For instance, if you earn $6,000 or more during 2019, then you can contribute the maximum contribution of $6,000 for the tax year. However, if you earn $3,000 during 2019, then you can only contribute up to $3,000.   What are the Income Limits? Because a Roth IRA has such great tax advantages, the IRS designates that you must fall within certain modified adjusted gross income (MAGI) limits. Your eligibility to contribute also depends on your tax filing status. For minor Roth IRAs, the income limits will be based on the minor’s income and not the parents.  Rest assured that for 99% of minor’s the income limit will never be an issue.  For 2020, you can contribute the full $6,000 as long as your MAGI falls below $122,000 for the year.   How can my child become eligible for a minor Roth IRA? Here are the three things that must be done for your child to become eligible to contribute to a Roth IRA, even if you are contributing the money on their behalf. #1: Your child must have earned income Even if they don’t bring home a paycheck, your child must have some type of employment compensation. This could be something as simple as earning money around the house for chores or babysitting. If you have a business, they could help with that as well. Some business owners even pay their children to model for photos used on their marketing materials. Don’t worry that the Fair Labor Standards Act states that the minimum age for employment is fourteen. They give the following exceptions that can be completed at any age.

• Delivering newspapers
• Performing in radio, TV, movies or theatrical productions
• Working in businesses owned by their parents (except mining, manufacturing or hazardous jobs)
• Babysitting
• Minor chores around a private home

Note: It may sound funny, but whether your child is considered an “independent contractor” or a “household employee” can have ramifications for tax purposes.  This article has great tips about how to best address this: https://www.marottaonmoney.com/fund-your-childs-roth-with-chore-income/.  As always, we encourage you to seek professional tax advice if you have further questions.   #2: You must open the account on your child’s behalf Because your child is a minor, a parent or custodian must open the Roth IRA on their behalf. They are responsible for contributing to the account and investing the money for the child in their best interest. At the age of eighteen, the account can be transferred into the former minor’s name. It will be designated as “Roth IRA” rather than “Minor Roth IRA,” and they will have full control.   #3: You must adhere to the contribution limits As mentioned above, the IRS sets contribution limits to Roth IRAs. Your child may not contribute more than they earn to the account while also not exceeding the contribution limit. The contributions can come directly from the child’s earnings, or a parent or other adult can contribute money on their behalf. What are the benefits of my child having a Roth IRA? Best Fit for Children Children are not eligible for the tax deduction associated with a traditional IRA because their annual incomes are typically lower than the standard deduction, which makes a Roth IRA the perfect fit. Compound interest A Roth IRA is a powerful tool for young investors who have many years until retirement. The earlier contributions are made, the more time they have to grow. Tax advantages A Roth IRA is perfect for those who will be in a higher tax bracket during retirement. When they take the money out, they will be keeping more of it because they do not have to pay taxes on it. Flexible use of funds Roth IRAs allow contributions to be withdrawn at any time. After five years, the funds can be used for a first-time home purchase without resulting in taxes or penalties. In addition, qualified education expenses can be withdrawn penalty-free by just paying income tax. Investing returns Even though it’s not guaranteed, standard savings accounts tend to provide much less interest than investing accounts do in returns. A Roth IRA lets you invest your child’s money in a variety of options that have much more potential for growth.