12/13/2010

Who can set up a Roth IRA? Anyone who has earned income (as in W-2 wages or self employment income) and as a single taxpayer has modified adjusted gross income of less than $120,000. Who does that describe? Lots of people – including YOUR KIDS.

Here is the rule: for 2010 and 2011, a child who earns income can contribute to either a traditional IRA or a Roth IRA the lesser of (a) his/her earned income or (b) $5,000. He/she can also do a combination contribution – some to a traditional IRA, some to a Roth with the same limitations – no more than earned income or a total of $5,000.

So – if you daughter works at Sonic all year and earns $4,750, she will have no income tax, since her income falls below the taxable limitations ($5,700 this year). She can sock away the entire $4,750 into a Roth IRA where it can grow tax free for a lifetime. Or she can withdraw the contribution portion without consequence to pay for college or a down payment on her first home (if she withdraws the whole enchilada before age 59.5, she will be taxed and penalized on the growth portion of the IRA). What’s that you say? She doesn’t have one dime of the money left to contribute to a Roth? You could gift her any amount up to $4,750 to fund the Roth and then figure out an incentive plan to help her make the 2011 contribution herself. Maybe matching dollar for dollar?  Just a thought.

If you own a business, here is another thought: you can hire your child for a job that he is capable of performing and in actuality does perform, and voila! The amount you pay him is earned income that can be used to determine the funding level for a Roth IRA. If your business is a sole proprietorship (you file Schedule C with your tax return), or a mom-pop partnership/LLC (you file Form 1065 or Schedule C), your child’s wages are exempt from Social Security, Medicare and FUTA taxes, and probably workers’ comp insurance. If your business is formed as a corporation, your child’s wages are treated as any other employee – fully impacted for Social Security, Medicare, FUTA/SUTA, workers’ comp and so on. But the payroll taxes are deductible to your business. By the way, when you pay your kids, you are shifting income from your high tax rates to their low tax rates. No kiddie tax on earned income. Win-win.

Where should your kid set up her Roth IRA? Anywhere that you would – running the gamut from savings or CD accounts at banks and credit unions all the way to trading accounts with an online brokerage like Schwab or TDAmeritrade. There is paperwork to be completed and deadlines to meet – for 2010, the Roth IRA must be funded by the tax filing deadline without extensions – usually April 15, but the tax deadline this year is April 18. A fluke related to a holiday….really.

And while you are helping your child to start saving for his or her future, remember to fully fund your retirement accounts, too. Especially your 401(k) at least up to the company match. What a role model!