If your teenaged child or grandchild is gainfully employed, they can contribute up to $5,000 a year to a Roth IRA. The contributions aren’t tax deductible, but at the child’s low tax bracket, it doesn’t matter. Let’s say the child contributes $5,000 a year between the ages of 16 and 21, and then doesn’t contribute another dime. If, over the long term, the Roth IRA earns 10% per year, the child will have over $2,500,000 at age 65. And the money will be 100% tax- free!
Does it sounds too good to be true? Well, it’s possible with the right tax planning and a very idealistic vision of retirement. You can basically call it the ultimate gift. Parents could make their child an adult millionaire by starting contributions as soon as they are employed. As it may be hard to imagine your child reaching retirement, a Roth IRA for your child can be very attractive and a powerful tax-free investment. An Individual Retirement Account (IRA) is one of the most incredible saving tools that are currently available. The Roth IRA was born on January 1, 1998 as a result of the Taxpayer Relief Act of 1997. A Roth account provides no deduction for contributions made, but instead provides a benefit that isn’t available for traditional retirement accounts. A Roth IRA is an account in which contributions are made with after-tax dollars and at retirement age, the contributions and earnings are withdrawn tax-free. Tax-free compounding of earnings inside a Roth IRA over a significant amount of years can pay off. The longer the funds stay invested, the greater the wealth accumulation.
There's no minimum age to set up a Roth IRA. Many IRA providers will accept accounts for minors, if the account registration includes an adult who will make decisions with respect to the account until the minor attains the age of majority under applicable state law. In most cases, the only issue is whether the child has “taxable compensation income” (not investment income). Taxable compensation is income received in payment for a personal service, such as wages, salaries, commission fees, and tips. There's no requirement that the same dollars that were earned be used to fund the IRA. For example, if your child earned money on a summer job and spent it on whatever kids spend money on these days, there's nothing wrong with using money provided by parents to establish the IRA. The child simply has to have earned income. Contributions may not exceed compensation earned by the child for the year.
It is important to note, any money contributed on behalf of your child belongs to the child. There's no way to restrict the child from withdrawing it and using it in any way they choose. Roth IRA’s are subject to what’s known as qualified distributions. One of the most important Roth IRA requirements is that a qualified distribution can only be taken after a 5 year elapse period from the year of initial investment and the account holder must be at least 59½ to not be subject to early withdrawal penalties.
We would all like to see our children be financially independent and offering this type of account would kick start their retirement future.
Should you have any questions regarding a Roth IRA or other retirement planning, contact your Marcum Tax Advisor.