Is your child enthusiastic about saving? Does he always grab the first after-school job that he’s offered every year? If so, you should seriously look at opening a Children’s Roth IRA for him.
Opening a Roth IRA
To be qualified under the Roth IRA rules, your child must had an “earned income”, like wages, which are presented on a W-2 or “net earnings from self-employment” form. You should note that any amount that you give to your child by performing household chores will not count as earned income, but earnings from mowing a neighbor’s lawn or babysitting may qualify.
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You cannot contribute and save more than you made so you may consider placing 100% of your child’s earnings to the account, but be certain that you keep yourself updated on the maximum allowable contributions each year. If you have your own small company, you can hire your son or daughter to work in your business and recompense him accordingly.
A sole proprietor who compensates his or her child who is under 18 years of age is not required to pay the state, federal, government, and any payroll tax on the wages. You should make sure though that you are paying a reasonable salary to your child for accomplishing the actual work. The good news is that, you can place the maximum amount of contribution in Roth IRA for children annually.
Advantages of Roth Account to Children
Children will not receive current tax deductions to their Roth plan, giving them the opportunity to build a savings account with high Roth IRA rates. A dependent child can earn up to $5,000, to include $250 rates of interest, capital gains and dividends, prior to paying the federal income tax.
Distributions made to a Roth IRA after the age of 59 ½ will be automatically exempted from state and federal income tax, supposing, of course, that the Congress does not modify the rules and policies in the future. Even if the Congress decides to modify or review the Roth rules at a later date, it is very unlikely that any modifications would be retroactive, so profits on a Roth IRA up until the point of change should still be tax-free.
You can use the Roth IRA to influence your children to save or work. Let them know about the possibilities and opportunities that they may get in the future when they start to save early. If your daughter earns about $4,000 on her part-time job, encourage her to place such amount in her Roth IRA. You can also ask her to contribute $2,000 and you’ll add the same amount to her account to match her contributions.
You can even take your money out in a pinch with IRA hardship withdrawals. In addition, you can withdrawal money to buy your first house.
A Roth investment advice that you should keep in mind is that there is no specific rule saying that the funds contributed in an IRA for a child has to come only from the child’s earned money.
There is one possible setback with opening Roth IRA for children. Similar to a “Uniform Gift to Minors”, custodial savings account, when your son or daughter reaches the “age of majority”, normally at age 18, he or she will have the full right and access to all of his or her funds in the Roth IRA and may withdraw all the money without your knowledge. In this case, the child will incur taxes on the earnings and will also need to recompense 10% as premature withdrawal penalty.