If your son or daughter had a summer or after school job this year, you should seriously consider opening a ROTH IRA.
To be eligible for an IRA, your child must have “earned income,” such as wages reported on a W-2, or “net income from self-employment.” Money you give your child for doing housework will not count as earned income, but earnings from babysitting or mowing the lawn may qualify.
You can contribute 100% of your child’s earnings to the account, up to a maximum of $ 4,000.00 for 2005. If your child earned $ 2,400.00 during the year, you can contribute $ 2,400.00 to a ROTH for him. If you earn $ 4,500.00 you can contribute $ 4,000.00. You have until April 17, 2006 to open the account and make your contribution for 2005.
If you are self-employed, you can hire your son to work in your business and pay him a salary. A sole proprietor who pays a salary to his child under the age of 18 does not have to pay the federal, and probably state, government any payroll tax on wages. Of course, the child must receive a reasonable salary for doing real work. You can put wages, up to the maximum of $ 4,000.00, in a ROTH IRA.
Your child will not receive a current tax deduction for contributions to a ROTH IRA, but most teens do not need the deduction. A dependent child can earn $ 5,000.00, including up to $ 250.00 in interest, dividends, and capital gains, before having to pay any federal income tax.
Distributions from a ROTH, after age 59 1/2, will be exempt from federal and state income tax, assuming, of course, that Congress doesn’t change the rules in the future. Even if Congress revises the ROTH rules in the future, the changes are highly unlikely to be retroactive, so ROTH’s earnings up to the point of the change should remain tax-free.
You can use a ROTH IRA as an incentive to encourage your children to work or save. If your child earns $ 4,000.00 from a part-time job, put $ 4,000.00 into a ROTH IRA for him. Or, if your daughter agrees to put $ 1,000.00 of her salary into a ROTH, give her a 3-for-1 match and add another $ 3,000.00.
There is nothing in the tax code that says money put into an IRA for your son or daughter must come from the child’s funds.
The $ 4,000.00 maximum applies for fiscal years 2005 through 2007. It increases to $ 5,000.00 for subsequent years. The maximum applies to all IRA accounts. You cannot contribute $ 4,000.00 to a traditional IRA (deductible) and another $ 4,000.00 to a ROTH. If you deposit $ 1,000.00 in a traditional IRA, you can only put $ 3,000.00 in a ROTH IRA.
If you put the maximum in one ROTH each year for your child starting in 2005, when he is 16, and continuing until 2010, when he will turn 21, and no other contributions are ever made, the account could grow. up to $ 500,000.00 by the time the child turns 65, depending on the interest rate over the years. And everything is completely tax free!
There is a potential problem opening a ROTH account for a child. As with a “Uniform Gift for Minors” custodial account, once the child reaches the “age of majority”, generally 18 years of age, they will have full access to all funds in the account and will be able to “take the money and run out”. . In such a case, the child will pay taxes on the earnings on the account and will have to pay a 10% penalty for early withdrawal.
