Roth IRA for my children ?

hi, all:

need your expert opinions !!

just read an article in "Costo Connetction" (published by Costco). A reader was asking a question (how to invest) about his granddaughter of 15 yrs old that already has $20k in Roth IRA.

I didn't know kids can open a Roth IRA account !! my kids already have 529. is it better off keep investing in 529 ? or is it better to open a new Roth IRA account ? what are the advantages and disadvantages ?

thanks !!!

This should be addressed in the Beginner sticky... But...

A Roth for a kid is great. It has a lot more flexibility for withdrawals... 529s can only be used for education (although they can be transferred to someone else if the current beneficiary doesn't go to college). The principal (original contribution) can be withdrawn at any time penalty free on a Roth.

The rub is that the kid has to have earned income. The Roth can only be funded to the extent that the child has real earned income. The income can be lawnmowing, garage cleaning, or whatever. The kid must file for taxes.

If you want to GIFT money to a child, you can gift the kid a dollar for dollar match (or whatever) and use the gift money to fund the ROth, but only up to the extent of earned income.

Under current financial aid rules, a Roth does not count against you in the college financial aid evaluation.

my follow-up question is: what is the best way to generate income for a kid? Can I hire my kid to clean my house for $2000 a year?

Hold the phone! The Roth contribution can only be up to the amount of EARNED INCOME. If Jr. makes $2K sweeping floors, then he can contribute only $2K to the Roth. The matching part comes from the Bank of Mom and Dad IF they want... Some folks do some sort of match that way... Jr. gets bored working for money he doesn't see... That way, Jr. takes his earned money (he sees it) and does whatever with it. Mom / Dad GIFT him the same amount (or whatever you want to do) and that money goes into the Roth if desired. The matching part is completely up to you.

I'm not sure what a kid can earn without paying taxes, but I think it's more that $4K. The max Roth contribution per year is $4K for 2006 and 2007 for those under 50 years old.

I think the Roth is way better than the 529, and agree a lot of people are pushing the 529 too much.

The earned income has to be real. You have to pay reasonable wages for real work. And... again... You have to file taxes. It's not real earned income for a Roth unless Jr. files a tax return.

bellwilliam said: so if I got this right. to get to maximum of $4k for Roth IRA:

1. JR. make $4k earned income. then contribute all $4k into Roth IRA.

or

2. JR. make $2k earned income. and put $2k in Roth IRA. Parent then can match that and put in additional $2k into JR. Roth IRA ?


just trying to think of a "way" to put all $4k into Roth IRA. My kid is only 3 and 4. not sure what is a fair wage is wage called allowance? how would you do it?
You're still misunderstanding the rules heavily. You can ONLY put it as much money into a Roth IRA as that individual earned in taxable wages. What you CAN do would be hypothetically have the kid earn 2,000 dollars which is not put in a Roth IRA, and then you then put in 2,000 dollars of your own money into the Roth IRA in the kid's name. The IRS doesn't really care about the exact source of the money invested as long as that person earned enough in taxable wages.

With the kid currently only 3 or 4, I doubt there is any way you can really do this right now. You could try, but I'd be very worried about the IRS happening to do an audit and deciding the wages you paid don't pass the smell test. The IRS has to be persuaded that the kids legitimately earned the money or they will view this as simply attempted tax evasion trying to exploit the Roth IRA loophole. While I'll let more experienced people chime in here, I suspect that if you something like this right now you're effectively simply gambling that the IRS won't catch you. (Once the kids are older you may have more options on how to do this.)

Edit: One extremely important point here. It ONLY counts for a Roth IRA if the money was earned working. Income for investments does not count at all with regards to income which can count for either a traditional or Roth IRA. (Simply being taxable income is not enough.)

http://www.fairmark.com/rothira/minors.htm

just read this. author is saying paying kids to do housework, is not going to cut it.

I guess JR. have to have a real job !!!

damn, how did that 15 yrs old granddaughter have $20k !! must be a hard worker !!

You must be talking about Education IRA, had been named under Roth IRA years ago. at least, at time (1998~1999) I opened the IRA account for my kids. The account was named "Roth IRA". The account is renamed as "Education IRA". But I still believe the Roth IRA for kids is Education IRA.

Go Education(Roth) IRA for your kids. It's best investment for kids, as I know.

I started it a while ago. (was $500 contribution a year by parents or anyone. now is $2k a year). I mainly trade stocks for them in the accounts. Now I am happy what I have done for them.

The money in your kids' Roth IRA could be used for their education. The only drawback, if it exists, is your kids mostly have to use that money first. Sometimes, your kids are talented enough for scholarship. But possibly they will lose it because your kids have money (Roth IRA) under their names.

Then you must be too late to open the Roth account.
As said, I started it 1998~1999. For education purpose only.

BTW, why not google "roth education ira". easy to get answer.

Roth and Education IRA are different.

Education IRA is now called Education Savings Account. http://www.schwab.com/public/schwab/home/account_types/college_custodial/education_savings
maximum per year is $2k. and you can start with your newborn

Roth IRA is like what these experts said. $4k maximum/yr (more if you are over 50), but you must have at least that much earned income. that's the catch !! good thing is you can withdraw Roth IRA early (with no penalty) to use for higher education.

Funding Roth or Education IRA for Kids may have side issues.

I heard some students had difficulty on getting scholarships or financial aide before they exhausted all funds in their own name.

There are a couple of basic things here. For starters, you just want a good way to save for your kids' education. You heard about using a Roth IRA for your kids' educational savings, but you did not understand the requirements, even after it was explained. First, I doubt a Roth IRA is the BEST way for you to save for your kids' education, in nearly all cases. 529's have come a long way, and depending on which state you reside, you may receive a state income tax deduction or credit. You need to do the leg work and find out about your own state.

To FULLY understand how you can setup a Roth IRA for your children, you need to understand how a Roth IRA works, overall, before you even try to apply it to your kids' situations. First, there is an annual contribution limit of $4K, unless you are in the catch up years (and it will go to $5K in 2008). You seem to have that part down. However, you can only contribute up to the earned income amount. So, if you earned $3K in a year, you can only contribute $3K, even if you have other funds. Someone else can put in $3K for you, but that is all you can do.

There are some VERY specific rules about establishing a Roth IRA for your children. For starters, there is a precedent that has been established that a 7-year-old can have a Roth IRA. This does not mean that someone younger than 7 cannot have one, but it does mean that a 7-year-old, or older, can. For a child to earn income at an age younger than the child labor laws indicate, the child must be employed by their parent(s), basically. Now, there are also some VERY beneficial rules that allow you to hire your child and neither you or your child would have to pay FICA or unemployment taxes, and no income taxes up to the standard deduction, but I will leave that for you to find.

The bottom line is, the child must file taxes to established earned income. In addition, the child can contribute up to $4K or the amount of earned income, which ever is less; that money can come from anywhere, but cannot exceed those requirements. The "match" is just a concept that parents can use to provide an incentive to their children. Junior earns $2K, but doesn't want to deposit it all in the IRA. So, you tell Junior to deposit $1K, and then he can keep the other $1K. Then, you deposit $1K for him. He still had to earn $2K, but he only deposited $1K of his own money.

You should turn your baby into a model. That way you can have the kid earning income the day it is born!

sjm8566 said: Would someone kindly direct me to a bank or broker who will open a ROTH IRA for a 16 year old? My son, who is employed part-time, would like to open a Roth, but eveywhere we've tried requires him to be 18.
Try contacting Vanguard. I know that I was able to open a ROTH IRA account well before I was 18 there. The worst case scenario would likely be something along the lines of you having some sort of custodial position related to the account.

Dus10 said: debentureboy said: I think the Roth is way better than the 529, and agree a lot of people are pushing the 529 too much.

Well, there are benefits to each. Many state's are now offering state tax deductions or credits for 529 contributions... in those cases, 529's rule.

That being said, there is much more to the children's Roth IRA concept. If you hire your own child in your unincorporated business (I think LLCs with only the parents as members are eligible too), you do not have to pay unemployment insurance or the employer FICA match.

And you get to deduct the wages from your own tax return like with any other employee. It is taxable income for Jr, but he doesnt pay any tax unless his income exceeds the standard deduction. So hiring/paying your kids is definately worthwhile (provided it is real work).

Not to forget the power of compounding when funding an IRA at this young age. A $4,000 ROTH contribution per year for all four years of highschool (and no contributions after that) will yield Jr something in the neighborhood of $2mil at age 68. Tax free to boot.

simplicity said: I am a bit confused as to what my options are. I have gifted my sister about $1000, she just finished college. She tutors on the side, but she definitely don't make more than the minimum income required to file. From what I understand based on previous comments is that she needs to file that $1000 as income and pay taxes on that in order to be able to contribute to the ROTH? I don't understand how that works since the $1000 is already taxed from me. Or am I mistaken that she do not need to file?

If I need to withdraw her contribution, what kind of penalty (if any) are involved at this point? I realize I have up to april 16th to withdraw any excess contribution to avoid penalty on the excess.
Gifts are not taxable income. Your sister may not show your gift as income. And in any case, only "compensation" income qualifies for an IRA contribution. In other words, if she did not perform services for the $1000 or receive it as alimony, it doesn't count towards IRA eligibility even if she reports it on her tax return.

There is no minimum required to file a return. You may file a return even if your income is $0 if you like. After you earn a certain amount, you are required to file a return, but you are perfectly free to file a return even if you earn a lesser amount.

You say she does tutoring on the side. Does she do this as a W-2 employee of some company? If not, she is required to file if she makes at least $400 (four hundred). She doesn't make that much?

If she contributed this $1000 to an IRA, YOU may not withdraw it. Even if you put it into her IRA, YOU may not withdraw it. It is now her property. SHE must withdraw it. You can't do anything unless you are her court-appointed conservator or something like that (assuming she is an adult).

If it turns out that an excess contribution has been made to her IRA for 2006, she may withdraw it plus the earnings on the excess contribution until April 17th. If she files either a federal income tax return or an extension by April 17th, the deadline is extended to October 15th. She will have to pay ordinary income tax on the earnings plus a 10% penalty on the earnings. She will have to file a 2006 income tax and report the earnings plus penalty on her 2006 return even though she withdrew it in 2007. Make sure she notifies the IRA custodian that she is taking a return of her 2006 contribution and earnings so that they code the distribution properly. She will have to file a 2006 return to pay the 10% penalty even if she has no other income.

simplicity said:
Junior earns $2K, but doesn't want to deposit it all in the IRA. So, you tell Junior to deposit $1K, and then he can keep the other $1K. Then, you deposit $1K for him. He still had to earn $2K, but he only deposited $1K of his own money.

Based on the example above, does Junior have to file his income based on his $2k earnings? I was under the impression that anything under $3k you are not required to file.

I don't know of any requirement that you must file an income tax return in order to make a Roth IRA contribution. The MSN Money article suggested (properly) that if you hire your kid in your business you should issue a W-2 and do all of the other paperwork you would need to do for any other employee. If the kid earned less than the filing threshold, he would not be required to file a return even if he made a Roth IRA contribution. But he must have the required compensation income. Practically speaking, the kid probably should file a return as it may head off an inquiry from the IRS.

You are totally under the wrong impression about the filing requirements. The filing requirements are on pages 12 and 13 of the Form 1040 Instructions. Since Junior is probably a dependent, he has to file if he satisfies any of the tests in either Chart B or Chart C.

Thanks again. I will look into that form but will most likely consult with my tax advisor as well to see if there are any other options available.

I opened a Roth IRA when I was 14 with my credit union. My mother had opened me a minor savings account and then they allowed me to open the Roth IRA in my name only (with my mother only). At the time, IRA contributions were limited to $2k per year. I did that each year until I graduated high school. In college, I focused on the 401k and mortgage, not contributing to the Roth IRA anymore (I know, stupid move). But by my Junior year, I began making my contributions again. Today (literally, this morning), I closed out this Roth IRA to move it to a brokerage. I had CDs until this point in that Roth IRA and the CU started charging a $10 annual fee. I had built up a good $11k (when I started contributing in college, I went straight to stocks and mutual funds at another brokerage).

EDIT: typos