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Earning a Roth

Richard Connor

HAVE YOU GOT children or grandchildren with summer jobs? That means you could put them on the path to financial success—by helping them open a Roth IRA.

My brothers and I always had jobs, including delivering newspapers, bussing tables, mowing lawns and valet parking. My sons also had jobs at an early age, including shucking thousands of ears of corn at our local swim club. Later on, they were lifeguards, along with many of their friends from the swim team.

We all remember our first jobs—fondly, I hope. Getting a paycheck, realizing how taxes work and learning what FICA means—Federal Insurance Contributions Act, if you’ve forgotten—are all invaluable lessons on the road to adulthood. But today’s summer jobs come with a potential added bonus: opening and funding a Roth IRA.

An IRA is a great way to introduce a child or grandchild to the world of saving and investing. A Roth IRA will almost certainly make more sense than a traditional IRA. Most children won’t owe income taxes on their slender summer earnings. That means they wouldn’t benefit from a tax-deductible contribution to a traditional IRA.

IRA contributions and earnings grow tax-deferred. But with a Roth, the account’s earnings can also be withdrawn tax- and penalty-free after age 59½. Meanwhile, the actual money contributed can be withdrawn tax- and penalty-free at any age. The rationale: Those contributions were made with after-tax income. If retirement seems too distant a goal to excite your children or grandchildren, you might let them know that special rules also allow penalty-free withdrawals before age 59½ for—among other things—a first-time home purchase or to pay college expenses.

Intrigued? There are several things to know if you’re helping a child or grandchild set up a Roth IRA:

  • A child must have earned income to contribute to either a traditional or Roth IRA. Even cash income from babysitting or lawnmowing counts.
  • Contributions to an IRA can come from any source, but can’t exceed the amount of earned income for the year. If your granddaughter earns $1,000, you can contribute $1,000 to her Roth, and let her save or spend her earnings on other things.
  • A child’s IRA must be set up as a custodial account by the parent or grandparent.
  • You’ll need to know the child’s Social Security number to open the account.
  • The account will be managed by the custodian until the child reaches the age of majority, generally 18 to 21, depending on your state’s law. Control of the account then shifts to the child.

To avoid possible complications, keep records of the child’s income. A W-2 or 1099 is usually sufficient. If the child works for cash, keep a log of his or her income in case the IRS should ever ask. The IRS has several rules defining when a dependent child must file an income tax return. If a child works for cash or has tip income, he or she may be liable for self-employment taxes.

Opening a Roth IRA and filing a first income-tax return are two great steps in a child’s financial education. I look forward to the day when my grandchildren have earned income so we can start them on a lifetime of investing.

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B Carr
B Carr
19 hours ago

We’ve all heard that if a person contributes the max to an IRA from age 18-30, then stops…that the contrary person who starts contributing the max from age 30-65 will never catch up to the early riser’s IRA results.

In 1995 as an experiment, I challenged my father to match my contribution to a Roth IRA for one of his grandchildren who was age 18. We planned to have the total contribution be $2000, the max at the time, and continue until she was age 30. The plan was explained to the object of the exercise. Unfortunately, the grandchild has zero financial savvy and she emptied the account the instant it was funded.

End of experiment. The grandchild struggles financially to this day. My father went on to surreptitiously fund Roth IRAs for his two other grandchildren but in far lesser amounts. They both emptied their accounts when they learned of them, too.

🙁

isrosenberg
isrosenberg
9 hours ago
Reply to  B Carr

That is so sad that the grandchildren didn’t at least maintain the account. Unfortunately, it’s a risk where grandparents and parents have very limited control. It makes me curious as to whether the behavior impacted any estate planning decisions.

Jonathan Clements
Admin
Jonathan Clements
18 hours ago
Reply to  B Carr

That’s awful — so short-sighted by the grandkids.

Darelyn Casebier
Darelyn Casebier
1 day ago

My daughter works part time while in college and contributes $50/month automatically to a Roth IRA. I match her contribution, and will continue to do so until she graduates and is working full time and contributing to her employer’s retirement plan. My goal is to teach her the value of early and regular contributions and compounding.

Jonathan Clements
Admin
Jonathan Clements
23 hours ago

Love it!

Andrew Forsythe
Andrew Forsythe
1 day ago

Great reminder, Rick. We funded Roth IRAs for all our kids many years ago and they provided a real jump start to their financial well being.

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