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Estate Planning

Ron Barnes, CPA, PFS, Manager

Roth IRAs for the Younger Generation

How can you teach your children or grandchildren to save for the future? It’s difficult, especially when their retirement is such a long way off. One idea: Inform them about the benefits of a Roth IRA. In fact, you can have them set up a Roth IRA just as soon as they earn their first full-time wages.

Even though the contributions are nondeductible, Roth IRAs have several attractive features not offered in traditional IRAs. Most important, the earnings within a Roth IRA compound tax-free rather than tax-deferred. Also, one can withdraw the funds after age 59½ without paying income taxes as long as the account has been open at least five years.

Roth IRAs have become popular investment vehicles for many people who want to save, but they work especially well for those who start at a young age. Availability of Roth IRAs is restricted for certain high-income individuals, but this generally should not be a problem for younger workers.

Although your children might not get overly excited about saving for a retirement that may be 40 or more years away, the flexibility of Roth IRAs makes them especially beneficial for various other purposes.

Your children’s contributions to a Roth IRA can be taken out anytime without taxes or penalties. The contributions and earnings are available for college expenses, but taxes will apply only to earnings withdrawn. In addition, five years after the account is opened, your children can use up to $10,000 to buy their first homes and not pay taxes or penalties.

There is no minimum age required to set up a Roth IRA. The maximum allowable contribution is based on earned income, not investment income.

In case your children or grandchildren have no earned income, you might want to consider hiring them to work in the family business. If they are under age 18, you won’t have to pay any federal payroll taxes such as Social Security, Medicare or unemployment, and you’ll get a business deduction for the wages paid.

If you don’t have your own business, get them to do real work around your home—for example, painting or mowing the lawn. Write down their job descriptions and actually give them a W-2 form at the end of the year.

Make sure your children are actually working for the money and you are paying only a reasonable hourly rate for the work. Furthermore, keep records of when the work was done just in case the IRS asks.

As long as your child is a minor, you’ll control the account. But once your child reaches your state’s age of majority, the Roth IRA belongs to him or her, and you cannot impose restrictions on how your child spends it. Nevertheless, show your child how the money would grow over the years and review the fund’s reports. Over time, your child will see the account grow and begin to appreciate the benefits of saving for the future.

Email Ron at Ron_Barnes@mnccpa.com