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:

  • Have the teenager earn money via traditional jobs like grocery bagger, cashier, food delivery, waiting tables, etc.
  • The child earns income from other neighborhood families doing things like babysitting, lawn care, or painting. The pay rate would have to be at reasonable market rates. You could even work out a “I’ll pay your kid if you pay mine” agreement, if you find a like-minded parent.
  • If you run your own business, you could pay the child for more clerical or administrative-type duties such as proofreading, delivering documents, or office organization.
  • If the teenager is especially industrious, they could be doing more skilled work like graphic design or making iPhone apps.

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)?

Comments

  1. jaybirdhgr says:

    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

  2. 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.

  3. hawks5999 says:

    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.

  4. 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.

  5. @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.

  6. 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.

  7. 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.

  8. 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.

  9. @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.

  10. 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

  11. 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.

  12. 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.

  13. 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.

  14. @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.

  15. i just went to
    http://apps.collegeboard.org/f.....on=reclyes

    to make sure that 25% was correct

    i went through, and the only assets i put down were 10,000 for the child
    there were 2 formulas
    one said the child owed 2000, the other 2500,

    so im guessing its between 20 and 25% of the students assets

  16. My son has just started working a part-time job, and I plan to match his income from that job in a Roth IRA. I’ve been planning on this for a long time, but he foiled those plans by not getting a job until now!

    As goonster says, if you are self-employed you have a good opportunity to pay your kids in this fashion, to do work for your company. Just make sure the pay is reasonable, and you can document that they actually performed work for you.

  17. I certainly am planning on doing this when my kids are old enough to have a real job. I would totally stay away from pass-through companies, paying your own kids for jobs, and all of those sorts of things. It doesn’t sound totally above board to me and it’s best to keep it squeaky clean.

    But when my kids turn 16 or 18 and they get a normal job earning a few thousand dollars at some local fast food place or wherever, I will certainly help them fund a Roth IRA. As I understand it, the law is that they must EARN the amount of income that is contributed, not that they have to save that amount from their earnings.

    I’m sure you and your readers know the math. $5,000 saved at age 16 will be enormous at age 65 or 70.

  18. Cool. Once my little one is old enough to get crap jobs you get when you’re a teen then I’ll definitely look into this. I’m already funding his 529 at about the same rate per year so this could be helpful in other ways. Nice.

  19. It might seem good to fund your kids IRA’s for many of you but I am in a different league. I have 2 kids of age 6 and 2 and I started their 529 as soon as they were born. I will give them everything and whatever education possible and fund as much as possible for their college and let them get a degree. Also help them to sart a business when they are legally possible and stand in their legs. That should take care of their future and let them decide their retirement. I am not going to fund their retirement but will surely put my assets in trust so it can be easily inherited by them after our days. I go with philosophy, “Teach them to catch fish and they will take care of their life instead of feeding them”.

    Alexandria is totally right about kiddie tax and child tax rate. She has to be being tax accountant. As CFP Candidate, I have learned that all unearned income get taxed in parents tax rate, all earned income are taxed after $900 deduction by child tax rate. You cannot include your child in your tax return if they have to show their income in their tax return. As per IRA being accounted for FAFSA purposes, retirement accounts are not considered for scholarships aided by government but as Jonathan right pointed out certain universities can count them for their individual grants.

    As many suggest, don’t go overboard with the Kids and IRA and try to get caught in the IRS auditing. As Alexandria noted, its not worth it. That’s my take

  20. Dangerman says:

    I think 1417 is encouraging borderline money laundering.

  21. Sounds like 1417 is a little bit shady.

    I’ve always been a proponent of maximizing your Roth contributions before a 529 since you can use the funds for kid’s college and it won’t affect financial aid like a 529 does…..but i hadn’t even considered doing an extra Roth for my kid. I love that idea and will be digging into it!

  22. I definitely must agree that this 1417 thing sounds like a sham and I hope they are shut down. All it is is a way to game the system by taking advantage of desperate or naive people while taking a huge chunk for themselves. Not to mention ripping off the Fed.

  23. Agree with Dangerman and Jack … I suspect 1417 will be visited by IRS agents soon and eventually shut down.

  24. Helping a working/ earning teenager contribute to IRA is great parenting. It is also a very good motivator – teaches them value of work and shows them how much their parents love them and want them to be responsible citizens.

    But trying to find loopholes to ‘employ’ infants and toddlers is downright cheating.

  25. We’ve funded our children’s Roths since high school (when they had part time jobs). I’m not sure I would bother if they were very young or use the 1417 service. Better to fund the 529 education fund or your own retirement. If I owned a business, I would employ the children over the summer so they would learn the business and develop a work ethic.

  26. ParatrooperJJ says:

    @Scott – The federal statute of limitations is 5 years for most crimes….

  27. My 17 year-old and 12 year-old will each have Roth IRAs this week. The 17 year-old has been eligible for a while, and the 12 year-old just became eligible, with over $1,000 in earned income from his paper route. Thanks for this advice!

  28. There is a lot of misinformation in the post and comments – I suggest a careful reading of IRS Publication 929 – Tax Rules for Children and Dependents.

    Assuming the earned income is legitimate (and I would really question 1417power as being legitimate), for tax year 2011 your children could each have earned up to $5,800 without any withholding (if they have no investment income).

    Both of my teenagers work for me and out of their earnings they not only fund their Roths but also pay for a lot of activities like soccer club, etc. This offers me a legitimate business expense (their salary), and I save more of my earnings because I’m no longer paying for some of their activities. Plus they are learning what things really cost!

    Every small business owner should be employing their children and getting them started on retirement savings. Just remember you have to give them legitimate jobs at a legitimate wage. No paying them $100/hour to sweep the floor of your home office!

  29. I don’t think it’s cheating to employ infants. If you own your own business, design an advertising brochure using your children’s pictures and pay the children for their release. That’s a legitimate advertising expense.

  30. Coverdell ESA is an option for the first $2k. AGI too high to contribute to Coverdell ESA? Worry not – gift $2k to the child and s/he can contribute herself/himself to the account. Unlike Roth IRA, there is no restriction that says the funding has to be earned income. It’s a loophole but not very large.

  31. Sorry to join this conversation so late, but Kid IRA pays kids and does not charge parents tuition. Free to sign up and free to maintain the account.

    For kids 0-12, we pay the kids a royalty fee for allowing us to use their image/picture on our site. The royalty is based on purchase volume. Think of it as “performance-based modeling.”

    For kids 13+, they take on more of an active role and their job responsibility is to be an “personal shopper.” They recommend stores, discounts, and coupons to their clients and get a commission based on the purchase volume.

    The main objective is to help our kids maintain a steady income of which to invest in their custodial Roth IRA, which we like to call a Kid IRA.

Speak Your Mind

*