Note: This post was originally published in May 2011. The below still has relevant information. For updated limits and tax laws, please visit Funding a Roth IRA for Your Child.
School is out, and your children are looking forward to a summer with their Xbox 360, what if you could help them work on their retirement savings? Imagine how your son would thank you if he knew that at age 65 he could have more than $585,000 in a Roth IRA, because you made him work one summer at age 15! Well, the thanks and gratitude might be a dream, but the savings can be a reality.
First, to fund an IRA, a child must have earned income. At Henssler Financial, we maintain that children can accumulate income from mowing lawns, baby-sitting or other household chores. If your child earns money by doing chores either at home or in the neighborhood, we suggest children accept checks and keep records of the employment. This way the IRS should not disallow the earned income as a “gift” or an “allowance.”
If you are in a fortunate position to conduct business as a sole proprietor, you can find substantial tax savings if you employ your children. For children under the age of 18, consider hiring your child and pay him through payroll. This could provide the extra help your business needs, while saving on employment taxes because children are exempt from social security, Medicare tax, and state and federal unemployment taxes. Teens can be hired to assist with filing, scanning or mail services. Pre-teens can help keep your office clean, and younger children have been known to model in advertisements. Whatever the job, you just need to make sure their wages are appropriate for the work they perform.
When a child has earned income, he is eligible to contribute to a Roth IRA—the lesser of the total earned income or $5,000. We suggest a Roth IRA for a child, because contributions are made with after tax dollars and withdrawals are tax free after the child reaches 59½. There are also no mandatory withdrawal rules for a Roth IRA. Providing even more flexibility, you are allowed to withdraw your principal contributions from a Roth IRA at any time, without paying a penalty or income tax.
If your child were to contribute to a Roth IRA at age 15, his investment should grow by the power of compounding interest for 50 years, or more. With such a long time horizon, we suggest 100% equity investments, such as, common stocks or mutual funds that invest in common stocks. You could easily choose an S&P Index fund, and receive about the same return as the market as a whole. The S&P averages about 10% return over long periods of time.
Assuming a 10% rate of return, with a one-time investment of $5,000 and 50 years of compounding interest, your child could have a nest egg of more than $585,000 by the time he reaches age 65. Furthermore, a Roth IRA need not be funded with a one-time contribution. A child who learns to save for the future while young will likely continue to contribute to his retirement fund throughout his career. If your child were to continue to contribute $5,000 each year until he reached age 65, he should have more than $6,400,000, assuming a 10% rate of return.
You could set your child on a path to have more than $6 million by the time he is age 65. And to think this all happened because you secretly thought the Xbox would be a waste of a perfectly good summer.
At Henssler Financial, we believe you should Live Ready, which includes learning to save early and often to secure a financial future for yourself. If you’d like to learn more, please contact Henssler Financial at 770-429-9166, or experts@henssler.com.
Disclosures
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
