Set Your Children Up For Success, Kids Investing In Roth IRA
by: Jeremy Reif, CRPS
In a recent client meeting, I was introducing one of my business owner clients to a CPA. During this meeting, we were talking about tax opportunities and ended up on the subject of funding Roth IRAs for their children. My epiphany during this meeting was saying that this is brilliant and we need to do a video and write an article about it as we talk about these tax-saving strategies all the time. I’m going to show you the ultimate guide to setting up a Roth IRA for your kids. Stick around to the end for an exciting twist on how to use it.
Roth IRA
So, what exactly is a Roth IRA? Well, it’s a retirement savings account that offers tax-free growth and tax-free withdrawals. It’s a great way to help your kids start saving for their future from an early age. The only catch here is there needs to be earned income.
I am going to breeze over the basics of Roth IRAs, and assume you already know that you can contribute up to $6,500 per year ’23, or your child’s earned income, whichever is less. This money can come from their own earnings, savings, or from gifts you give them.
Business Scenario
In this specific case, a business owner was paying their children an allowance. We uncovered that was from their personal savings. Now, there is nothing wrong with this, but the goal is to be as efficient as possible and minimize taxes for everyone. The conversation went on to question why not pay their children wages from their company. In this case, the children were doing chores on their family farm. The determination was to put the children on the payroll. This is a tax deduction for the business and then the children having income are now eligible to fund a Roth IRA.
Invest
This article is not about how to invest the money, but this is a quick disclaimer. Once the money is in the account, it’s time to invest. Remember, a Roth IRA can hold various investments like stocks, bonds, or mutual funds. It’s important to choose investments that align with your child’s goals and risk tolerance. Since most children more than likely have zero investing experience it is important to discuss how this should be invested.
Power of Compounding
The compelling reason for starting the Roth early allows for the power of compounding. Since the money grows tax-free, the earlier you start, the more time it has to grow. Often the conversation with many investors is that they wish that they had more time to invest or had started earlier. That’s why starting a Roth IRA for your kids can really give them a head start in building wealth for their future.
Your child can withdraw their contributions (basis) prior to retirement without penalties or taxes. Please note there is a 5-year rule that is not discussed in this article.
*New Strategy For The Roth
Here is the twist that was promised earlier in the article. Did you know that the money in the Roth IRA does not count towards Federal Student Aid (FASFA) as it is deemed retirement money, whereas checking, savings accounts, and 529 plans do count in the FASFA calculation? Once the children are eligible for college or higher education, the money in the Roth could be used to pay for tuition without taxes or an early withdrawal penalty. Please note: Distributions from a Roth IRA do count towards qualifications for student aid (FASFA), whereas owning one and having a balance does not count.
So, to recap, open a Roth IRA for your kids, contribute to the account, choose investments wisely, and let the power of compounding work for them. It’s an incredible opportunity to set them up for a financially secure future.
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