Are you a hyper-advocate of the Roth IRA? Do you wish your 13-year-old or ambitious second grader could put money into one of those accounts? Well, she just might be able to contribute to a Roth IRA starting now.
As a refresher, a Roth IRA is a retirement account where withdrawals are not taxable if taken out at age 59 ½ or later by the account owner. The investments gains are essentially tax-free if you follow the rules. You can only contribute to a Roth IRA if the “account owner” has earned income in an amount that is at least as much as the contribution. Earned income is income that was acquired by working a job as an employee or self-employed.
So, how does your kid who is below the legal age to work get earned income? You employ them. Do you pay your child to babysit her younger siblings, mow the lawn, or take out the trash? That is earned income to the child. This income is not subject to FICA, Medicare, or federal unemployment taxes since it is paid by a parent as long as the child is under 18 years of age. Also, as long as you keep the income under the standard exemption thresholds there would not be any income tax due on the earnings. States may vary on the standard deduction. In addition, you may want to check into state unemployment requirement thresholds to make sure you do not inadvertently owe state unemployment taxes. A W-2 issued by the parents to the child would be required if you paid your kid $600 or more.
If you are paying your kids to do chores around the house you could have them get a super head start on their retirement with possibly 50+ years for the money to grow tax-free. That sounds like a much better use of the money then scented pencils and Pokemon cards.
As always, make sure you run this plan by a qualified tax professional before doing it. Most tax situations are unique.
-Dan Busenbark, CPA