Consider having your kids contribute to a Roth IRA account
If you have a teenage child who works, consider encouraging the child to use some of the earnings for Roth IRA contributions. All that’s required to make a Roth IRA contribution is having some earned income for the year. Age is completely irrelevant. Specifically, for both the 2015 and 2016 tax years, your child can contribute the lesser of: (1) earned income or (2) $5,500.
By making Roth IRA contributions for just a few years, your child can potentially accumulate quite a bit of money by retirement age. Realistically, however, most kids won’t be willing to contribute the $5,500 annual maximum even when they have enough earnings to do so. Be satisfied if you can convince your child to contribute at least a meaningful amount each year. Here's what could happen if a 15-year-old makes the following Roth IRA contributions starting now:
Why the Roth IRA Is Usually the Better IRA Option for Kids
For a child, contributing to a Roth IRA is usually a much better idea than contributing to a traditional IRA for several reasons. The child can withdraw all or part of the annual Roth contributions—without any federal income tax or penalty—to pay for college or for any other reason. (However, Roth earnings generally cannot be withdrawn tax-free before age 59½.) In contrast, if your child makes deductible contributions to a traditional IRA, any subsequent withdrawals must be reported as income on your child’s tax returns.
What about tax deductions for traditional IRA contributions? Isn’t that an advantage compared to Roth IRAs? Good questions. There are no write-offs for Roth IRA contributions, but your child probably won’t get any meaningful write-offs from contributing to a traditional IRA either. That’s because an unmarried dependent child’s standard deduction will automatically shelter up to $6,300 earned income from federal income tax in both 2015 and 2016. Any additional income will probably be taxed at very low rates. Unless your child has enough taxable income to owe a significant amount of tax (not likely), the theoretical advantage of being able to deduct traditional IRA contributions is mostly or entirely worthless. Since that’s the only advantage a traditional IRA has over a Roth IRA, the Roth option almost always comes out on top for kids.
Having kids make Roth IRA contributions is a great way to introduce the ideas of saving money and investing for the future. Plus, there are tax advantages. It’s never too soon for children to learn about taxes and how to legally minimize or avoid them. Finally, if you can hire your child as an employee of your business, some additional tax advantages may be available.
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