Pay Your Kids To Fund Their Own Roth IRA?
You’re probably aware of the wonders of the Roth IRA and how it allows your money to grow completely free from taxes, even upon withdrawal. An added wrinkle is the lack of age restriction, so that even kids with earned income (wages, salaries, tips) can contribute to a Roth IRA up the lesser of their taxable income or $5,000.
Along those lines, I received a PR e-mail from a site called 1417power.com. The idea is that you pay them “tuition”, and in return they pay your kids official job income that makes them eligible to contribute to a Roth IRA. They claim to follow all applicable child labor laws for those aged 14 to 17 (thus the name). Your kids do thing like fill out marketing surveys, but you’re essentially buying them a job. Digging through their fee structure, roughly 50% of what you pay them is skimmed off to go to the site owners.
Naturally, my question was – why can’t I just do this myself? The idea of paying your kids to do things like babysitting, lawn care or landscaping work, or manual labor seems simple enough. However, this Fairmark article argues that paying your own kids for chores is usually not considered taxable income, so you can’t “switch it” to taxable income for Roth IRA purposes when it benefits you. I’m not completely convinced, but for the sake of argument let’s explore other options:
There would still be some loss, as their gross income would be subject to payroll taxes like Social Security and Medicare, as well as a small amount of federal income taxes (less than 10%). But if your child has the discipline to not touch the money for decades, the tax-free growth could be enormous. You’d have to be comfortable with the fact that they could do whatever they wanted with the money at age 18 as they can withdraw the money after taxes and penalties.
The Parental IRA Match
Another move taken from this Forbes article for those that are already parents of teenagers with part-time jobs is to match their earned income. If little Jane earns $3,000 being a lifeguard, then let her spend her all or part of her take-home pay, but help her fund a Roth IRA to the full $3,000.
Effect on College Financial Aid
From my quick research, it appears that retirement accounts like Roth IRA are not considered an asset by the generic FAFSA form, but individual universities may deem them as a student asset. This could make for example 25% of the IRA to counts toward the student’s expected contribution, which doesn’t seem too bad.
Here’s a question for the parents out there – have you done anything along these lines? What did you do and why (or why not)?
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@Nuri – I didn’t know it was 25% a year. If that’s the case, then this would be best for parents whose income and assets already disqualify them for most forms of aid. It is good that you can withdraw from Roth IRA for qualified education expenses without penalty or taxes.
Thanks to all the other parents who are sharing their experiences! I knew there would be some out there. Modeling seems like a clever option, my niece did end up on a promotional calendar several years back.
I have done this with my 9year old son at our office. With help from our cpa and attorney.
We complied with state labor laws and set up a reasonable wage for duties at the office when he is on school holidays.
Tasks such as shredding, trash, filing, pdf scanning etc. Have kept records of time/dates of work.
Last year he did not work enough to generate own tax liability but this year plan to max out and then will file for him and have placed all earnings into a custodial roth ira at schwab and invested in index funds to start.
I initially wanted to start him at 5 or 6 but our cpa frowned and informed us that flags might go up at that age and you really want to be able to prove that child actually has some earned income.
I have several colleagues who do this and all have consulted with business attorneys/cpa before setting this up.
Actually, I attended a continuing education class (I’m a CPA) whereby the instructor employed her toddler grandchild for the purpose of funding a retirement account for her grandchild. What she did was she had professional photos taken of her grandchild for the purpose of including the pictures in advertising and promotional material. For using the grandchild’s pictures, she paid the grandchild $5,000. She then funded a Roth for the grandchild.
The activity triggered an audit. She was able to defend her position by showing the advertising material with the grandchild’s pictures on it and arguing that her grandchild was compensated for modeling services.
My parents did the matching thing for me, but chose a tech-based mutual fund which lost all its value in the 2000s. It’s the thought that counts, though.
As for hiring your young children – I would think hiring them as models for any advertising your company does would be an acceptable job for a toddler to have. But it would probably be best to consult with a lawyer.
Another benefit is being able to withdraw early without penalty for qualified higher education expenses. MotleyFool did a great job detailing Roth withdrawals and penalties. http://bitly.com/wJtkYf
@hawks5999 – From what you wrote here, it’s obvious you are trying to “beat the system” and commit tax fraud, or violate child labor laws, or both. One word – STOP. There is no statute of limitations on these offenses and you don’t want to be in jail 30 years from now when the government figures you out when you should be enjoying your grandchildren instead.
Only passive (investment) income earned by a dependent that exceeds $900 will be taxable to the parents at their highest rate, all other income is taxable to the dependent starting at the lowest bracket.
P.S. & in this case, actually consulting a CPA or tax professional would probably be cheaper, anyway. So is what I would recommend. It sure beats getting in hot water with the IRS! The thing with these kind of things is once you get the blessing and know how to handle it, you can probably easily handle on your own from that point, anyway.
Um, earned income has absolutely no affect on the parent’s taxes. The child pays taxes at their rate. Others are thinking of kiddie tax, which only applies to *unearned* income (i.e. investment income).
You definitely can not hire a 1-5 year old for anything.
AS far as 1417power.com – holy crap that is a steep “commission.” I’d pass.
If a child wants to report their income to the government, the government is not going to stop them, and is not going to raise an eyebrow. Whether it be for chores, or whatnot. That is my basic understanding. I am a tax accountant, and people in my profession do this all the time with their kids. That said, I think even though I Would 100% know what I am doing, there is an element of “not really worth all the hassle.” I’d think hiring this out to a third party would be extremely risky business (for one, I’d be far better equipped to defend my position than the average person, and secondly, who knows if they are handling it correctly). So, for all of the above, I’d say it’s probably not worth it. Unless you are well off and hire a GOOD accountant to figure this all out for you. As people often do. I’ll probably re-evaluate when my kids are 10 or 12. I don’t remember all the details off the top of my head, otherwise. IT is a lot of hassle.
@Jonathan
the fafsa tax is per year, as in they expect 25% of child’s assets to be used towards school each year. so after 4 years, if you don’t touch the principle, you pay 100% (or more if the investments go up)
so that would seem like a major wrinkle.
I agree with what Andy says about marginal tax rates and what hawks5999 says about hiring infant children. If anyone knows of a solution, let’s hear about it.
I want to find a way to hire my 5, 3 and 1 year olds by my LLC so their retirement savings can be fully funded before they graduate high school.
This only changes your idea a little, but I believe that if you can claim your child as a dependent on your taxes you may have to include their income on your return to a certain point. In other words, their income would be taxed at your marginal tax rate, not start from scratch with their own tax brackets.
ShareBuilder has $50 Bonus for opening Roth IRA account and depositing $200. Nice bump if you’re interested in helping out one of your kids. Details at http://cdn.content.sharebuilde…..ment/sb50/.
h/t FW