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Roth IRA for Children

Multi-generational wealth planning should always include consideration of a Roth IRA for minor children. Young children can meet compensation requirements for a Roth IRA under IRS guidelines through employment by others and/or through employment by parents.

The exponential compounding over an extended investment period makes starting a Roth IRA at an early age greatly desirable.

A person can contribute $5,000 or 100% of earned income, whichever is less (for 2009) to a traditional IRA or Roth IRA. The contribution to the traditional IRA is deductible from taxable earnings whereas the Roth IRA contribution is not deductible.

Tax Benefits for Children Holding Roth IRAs:

Children (under 19) generally have low incomes and pay little or no taxes.

Consider an example: Roy, age 13, earns $3,000 of compensation in ’08. (“Kiddie tax” does not apply because Roy’s income is earned, not unearned). Roy decides to open a Roth IRA and contribute all his earnings to it.

1. Earned income of $3,000
2. Standard deduction for dependents (larger of $900 or $300 + earned income - $3,000 + $300) =$3300
3. Roy will have no federal tax burden
4. His $3,000 contribution is tax free

Compensation (defined by IRS) – includes wages, commissions, fees, tips, and other amounts received for personal services.

Children can receive “wages” from employment in several different ways:

1. After-school job – golf course, store, etc.
2. Parents (self-employed, sole proprietors) can hire children to help with a business function
3. Parents can pay children a reasonable wage for doing housework (no federal income tax required to be withheld for household employees – parents are responsible for meeting filing requirements including an IRS Schedule H, a W-2 for each child, and a W-3
4. Self-employed children (baby-sitting, lawn mowing services, etc.) will file a Schedule C and SE

A Roth IRA contribution of $3,000 at age 13 through age 18 with an annual average return of 6% will compound to $253,568 at age 60 ($388,617 @ 7%, $593,343 @ 8%) and at age 70, this amount would be approximately $454,102 @ 6% ($764,470 @ 7%, $1,280,984 @ 8%) – TOTALLY TAX FREE!!! – WITH NO REQUIRED MINIMUM DISTRIBUTIONS!!! A traditional IRA using the same scenario will be 100% taxable.

If the child earns $3,000 per year but does not wish to place it into a Roth IRA (due to immediate needs, such as school expenses, etc.), any gifting to the child by parent or grandparent can be used to fund the Roth as long as the child has earned income of the amount contributed to the Roth!

THIS IS AN EXCELLENT WEALTH PLANNING OPPORTUNITY for parents or grandparents with children/grandchildren who “earn compensation” in any fashion.