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 But with a Roth, the account’s earnings can also be withdrawn tax- and penalty-free after age 59½. Meanwhile, the actual money contributed can be withdrawn tax- and penalty-free at any age.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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