What are Kids eligibility for ROTH IRA?

[Guest gchung]

I thought IRAs were limited to earnings but recently saw a note about someone opening a ROTH IRA based on his son's summer earnings of mowing the lawn. Is this true??? How can he do this?

I have 2 young children. My daughter just got her first job and my husband and I are considering opening an IRA which will match her earnings this year (noting the max allowed).

[John G]

Children having Roths is allowed by IRS rules. They need to have earned income. Lawn mowing, babysitting, newspaper routes all would clearly be earned income. I would assume that if the income was modest, they might not need to file a tax return but still would qualify for a Roth.... however, the accountants that comment here should weigh in on that point. At a minimum, you need to do some documentation for your files on the earned income basis and keep that file for many years. Yes, you can fund their Roth as there is nothing that says that the funding must come from the child.

You may find that not every custodian is willing to have an account for a child. For example, last time I checked Etrade will only open an account for someone over 18 years old. Their rules not the IRS rules. Charles Schwab does allow accounts, but a parent will be the "custodian". You may want to check around to find out your choices and what fees, if any apply. Start with your brokerage firm and mutual fund families as they may be willing to do something for an existing customer that they would not do for just a child. Also, you can ask for any fees to be waived... doesn't hurt and some custodians will say yes.

I suggest that you use the IRA activity as an introduction to your child for the world of investing. Give them a huge leg up by letting them learn a little about investing. I find that in my Junior Achievment high school classes that ussually 2-3 kids in each class have parents or grandparents that have gotten them started on the Roth.

Final note: you should also look into the revised Education IRA to see how it fits with the wage earner and the younger children.

Post again if you have additional questions about investment choices.

[i am back from 4 weeks in Europe. Will be posting again]

[papogi]

I've done this very thing for my daughter. Her income was too low for most mutual fund minimums, even the lower IRA minimums. Yes, some custodians do have an age limit, so that further limits your choices. The Capstone Group of funds was my best choice. $200 minimum, no age minimum, a low $2 annual IRA maintenance fee, and access to index funds with low expenses (not as low as Vanguard, but not bad).

[Guest gchung]

I agree that their income would be too low to warrant federal and state would taxes, but don't you have to pay FICA and medicaid regardless?

so in order to take advantage of a ROTH for my child with lawn mowing and babysitting fees would I have to fill out a tax form to pay the FICA and medicaid taxes?

It still might be worth it. As for documenting their income that's not a problem and makes clear sense.

I'm clearly interested in persuing this as I can't ignore the fact they they can earn 50 years of interest towards their retirement and have a nice reminder from their parents long after we've been gone

[papogi]

If anyone, regardless of age, makes at least $400 in self-employment income in a year (this would include lawn mowing, etc.), then Forms 1040 and SE must be completed. If the child earns less than $400, there is nothing to file with the IRS. Just keep good records of the earnings for the child. Receipts are ideal.

[Guest gchung]

Great. Thanks

[John G]

If the opening balance is an issue, you could consider waiting to Jan-April next year when you would be able to have a 2002 and 2003 contribution. You can contribute to a Roth before the actual earned income occurs. Just as you can ask a custodian to waive the annual fees, you can also ask them to waive the minimum to start if they understand your plan. IRA money stays put for a long time and custodians very much are eager for this business.

The verrrrry lonnnng term compounding is a huge plus. I know a few grandparents that are using this option to slowly shift assets over likely heirs under favorable conditions.

If you own your own business, you can hire your children for filing, copying, cleaning the office, making deliveries, etc. to boost their income. This is what I have been doing for 4 years, and both kids got some exposure to the business world.

[Guest Taxman]

papogi

I would add one small twist for people who don't mind being moderately aggressive in their positions with the IRS.

First, don't forget the son or daughter exemption for purposes of services provided for a familiy business operated as a sole-proprietorship.

Second, don't forget about the non-cash payment rules for casual labor that applies to EVERYBODY. Noncash payments for casual labor are fully exempt for FITW, FICA, and FUTA [iRC Secs. 3121(a)(7)(A), 3306(B)(7), and 3401(a)(11)]. So, if I hired my son for one-month to repaint the house, and paid in the form of a new jetski, that would be earned income for purposes of any IRA and would not be subject to payroll taxes. Further, presuming that he had no other forms of income, the standard deduction would be earned income + $250 (pers. exemp. would be with parents), so no filing requirement would exist. I would then gift the cash to him to make the IRA contribution. Also, a neighbor could employee my son and pay in the form of noncash property.

Keep in mind that all of this must be done with an arms-length approach. Clearly, if the value of the jetski is far in excess of the value of the services my son provided, the IRS would assert substance over form. Also, it is very important to stay within the definition of casual labor [iRC Reg. Secs. 31.3121(a)(7)-1(a), 31.3306©(3)-1(B), and 31.3401(a)(4)-1(B). Work routinely performed in or about a home by a caretaker, handyman, maid, etc. is clearly domestic service and not casual labor. The work must be isolated or nonroutine, such a carpentry, painting, etc...

[John G]

I like the above note. That a teenage has earned income is not very hard to believe given all the options for neighborhood jobs. I just don't think the IRS will ask any questions or documentation if all of the paperwork is done correctly. There is just not enough money at stake and the probability tilts in favor of the teenager having income.

However, if the child is under age 10 you might have a much harder time proving earned income and documentation would be much more important. You just don't want to try and tell a judge or auditor that your 8 year old was "clerking". They know better.

Remember that you can still do the educational IRA for a young child.

[Guest gchung]

This is all great information. Thank you all for adding to it. We even found out that our local bank do have ROTH Ira's for as low as $50 - it's more of a CD format, but gives them a start.

The point of the ROTH Ira is we want to start teaching our kids to save for their retirement with their first job so when they are in the mainstream work force it becomes a habit.

[John G]

STOP!

A $50 annual fee for an IRA is way too high. First, you can ask any custodian to waive the fee and some will since IRAs are considered long holding period accounts. Second, if you take the IRA to any firm where you have other business or your own IRAs they will often waive the fee if the combined assets are above 5k or 10k.

There are also plenty of custodians that either have no IRA fee or a very low fee like $10 to $15.

Try Charles Schwab, Vanguard Funds. Etrade used to have zero fee IRAs but they have been making a lot of fee changes recently so that may not be still true. Shop around.

CDs are an ultra conservative option for investments. You are barely going to stay ahead of the long term rate of inflation. I would recommend a balanced stock fund or general index fund with low expenses. Try reading Consumer Reports March issue for some ideas. Even in this market, I recommend for the long haul a significant percent in stocks.

[Guest gchung]

It's not an annual fee, it's minimum to open up the account. We figure as the kids are building it this is fine, then we can roll over to another one when we get $1000