Funding a child's Roth IRA when they work

[The Cosmic Avenger]

I've thought for years that the best gift we could give our child was a head start on retirement. When they start their first job, I want to encourage them to contribute the first $6K they make per year to a Roth IRA, and give them a cash gift to match whatever they contribute. (Chances are they would not make nearly that anyway since these would be summer jobs, as they are currently a junior in HS.) Basically, put money in a Roth IRA for them by matching whatever they make, although legally it would be their income that would be contributed, we would just make them whole immediately by gifting them a matching amount.

I can't see a downside, but any tax or other implications that I might not have thought of? Financial aid issues? (We have a 529, but not enough to cover all four years, we're planning on getting back to our LBYM roots and paying cash for most of it.)

 

[dtbach]

I can't see any downside for the kids. Wonderful thing to do.

 

[RetiredAt55.5]

minimum investment amount

An issue would be initially opening the account, since fund companies typically require a minimum investment amount to open an account (e.g., $3,000 for many Vanguard funds).

So your child would have to contribute at least $1,500 to get started (and have at least $3,000 of earned income).

 

[Buckeye]

And taxpayers with a tax liability and earnings up to a certain amount get a nice bonus from the Feds in the form of the Savers Credit. I helped my niece with the paperwork and some seed money to start a ROTH IRA this year. With a 50% credit at her low income level, she wiped out her tax liability for 2018. Free money!

 

[Buckeye]

An issue would be initially opening the account, since fund companies typically require a minimum investment amount to open an account (e.g., $3,000 for many Vanguard funds).

So your child would have to contribute at least $1,500 to get started.

Vanguard will let you open an IRA with $1,000 if you purchase a target retirement fund. I know because I just helped my niece get her first IRA opened. It took almost 3 weeks to get all the paperwork straight and for them to get enough proof that she was who she said she was (young, no credit history). Luckily, we started 6 weeks before tax day.

 

[FlaGator]

Agree with the idea. Matched the oldest’s earnings 1:1 for the last 2 tax years. She hit the max in 2018 and will in 2019.

Have another behind her, and he understands compounded returns[emoji2]

 

[The Cosmic Avenger]

Thanks for the reminders about minimums! I just checked and Fido has a Roth IRA for Kids, it turns out, with no minimums (although it doesn't abrogate any minimum initial investment for individual ETFs or mutual funds).

Buckeye, you actually hit on one of my biggest uncertainties. It occurred to me that the minion will probably make less than $6K this summer, so I wasn't sure how much could be considered EARNED income, and how much would be withheld. That's probably the part where I'm fuzziest. If she made $4K but had $500 in taxes withheld, can that child contribute $3500 or $4K? I suppose you could wait for a refund, then have her put that in the Roth (and possibly match that, too), right?

Also, I've been searching, and I can't find anywhere a clear definition of "earned income" with regards to SS and Medicare tax in particular, because they affect even the lowest earners, I think. It's not a lot, but still, I want to get it right and try to help the kid max out their Roth savings.

 

[kaneohe]

..............................

Buckeye, you actually hit on one of my biggest uncertainties. It occurred to me that the minion will probably make less than $6K this summer, so I wasn't sure how much could be considered EARNED income, and how much would be withheld. That's probably the part where I'm fuzziest. If she made $4K but had $500 in taxes withheld, can that child contribute $3500 or $4K? I suppose you could wait for a refund, then have her put that in the Roth (and possibly match that, too), right?

Also, I've been searching, and I can't find anywhere a clear definition of "earned income" with regards to SS and Medicare tax in particular, because they affect even the lowest earners, I think. It's not a lot, but still, I want to get it right and try to help the kid max out their Roth savings.

IRS uses a different term........taxable compensation. I think that means for the "simple" case, that it's what you think of as the salary. I believe you're taxed on the whole amount even tho SS/Medicare is taken out so the whole amount could be contributed to Roth if <maximum. Less simple is if you have pre-tax withholdings for 401K .........there you aren't immediately taxed on the 401K withholdings so you could only contribute what was remaining after the pre-tax withholdings.

 

[kaneohe]

And taxpayers with a tax liability and earnings up to a certain amount get a nice bonus from the Feds in the form of the Savers Credit. I helped my niece with the paperwork and some seed money to start a ROTH IRA this year. With a 50% credit at her low income level, she wiped out her tax liability for 2018. Free money!

The Savers Credit is a great thing so don't miss it if you're eligible.
Unfortunately it probably won't work in the OP's case. Right at the top of the form for claiming the credit: (might be 3 strikes here)

You cannot take this credit if
• The person(s) who made the qualified contribution or elective deferral (a) was born after January 1, 2001; (b) is claimed as a
dependent on someone else’s 2018 tax return; or (c) was a student (see instructions)

 

[Stormy Kromer]

I did this for a couple years for both kids a few years ago when they were working in High School. No regrets, it got them both started and I set them up with a monthly EFT as soon as they started working full time. A painless way to start.


The mistake I made was using a Financial Planner. He set them up in front loaded funds with a 5% sales charge......I learned and switched them to Vanguard, Target Fund 2065. I would not object to a 100% stock fund such as Total Stock Index or S&P 500, but I wanted something that I could tell them to "set and forget" and it will adjust accordingly as they get closer to withdrawing the funds.

 

[RunningBum]

I don't believe the Roth itself is considered as an asset in financial aid, but their wage income is. Also, it's possible your gift of the money for the Roth would also be considered as income.

 

[The Cosmic Avenger]

The Savers Credit is a great thing so don't miss it if you're eligible.
Unfortunately it probably won't work in the OP's case. Right at the top of the form for claiming the credit: (might be 3 strikes here)

You cannot take this credit if
• The person(s) who made the qualified contribution or elective deferral (a) was born after January 1, 2001; (b) is claimed as a
dependent on someone else’s 2018 tax return; or (c) was a student (see instructions)

Yes, they hit all three disqualifying factors! Thanks, kaneohe!

A lot of things to think about in this thread. I may have to do some research! (Normally I just figure it out as I go through trial and error, like adjusting withholding or reading IRS pubs on certain credits or deductions.)

 

[mrWinter]

I can't see a downside

Potential downside I see is that you and they are locking that money away in a retirement vehicle, inaccessible without penalties. You are starting to build their retirement savings account, but perhaps the best way to support eventual retirement is investment at this age rather than saving. Money that could go to college, or grad school, or pay of loans for either, or a down payment on a first home, or purchase of a first car without a loan, all could be wise investments.


My high school and college summer jobs paid for my first car, and contributed to my first home down payment, I was certainly glad to have that money accessible in my 20s. It costs some real money to get your feet under you and running in life.

 

[sengsational]

I did that with both of my kids' assistanceship wages when they were in college. Schwab had a $500 minimum at the time.

 

[TrophyWife]

We do this!

 

[hausfrau]

This is a fantastic idea. It never occurred to me to do this. This is something I would like to do too. If a kid has a Roth, does it affect their college financial aid since it's their asset? I don't think we will qualify for aid anyway, so it's probably moot.

 

[onabreak]

Thanks for the reminders about minimums! I just checked and Fido has a Roth IRA for Kids, it turns out, with no minimums (although it doesn't abrogate any minimum initial investment for individual ETFs or mutual funds).

Buckeye, you actually hit on one of my biggest uncertainties. It occurred to me that the minion will probably make less than $6K this summer, so I wasn't sure how much could be considered EARNED income, and how much would be withheld. That's probably the part where I'm fuzziest. If she made $4K but had $500 in taxes withheld, can that child contribute $3500 or $4K? I suppose you could wait for a refund, then have her put that in the Roth (and possibly match that, too), right?

Also, I've been searching, and I can't find anywhere a clear definition of "earned income" with regards to SS and Medicare tax in particular, because they affect even the lowest earners, I think. It's not a lot, but still, I want to get it right and try to help the kid max out their Roth savings.

We do this as well.
Taxes don’t impact their earned income. I just look at the last paystub for the summer and then deposit that amount in the Roth.
No issues so far.

 

[RunningBum]

Potential downside I see is that you and they are locking that money away in a retirement vehicle, inaccessible without penalties. You are starting to build their retirement savings account, but perhaps the best way to support eventual retirement is investment at this age rather than saving. Money that could go to college, or grad school, or pay of loans for either, or a down payment on a first home, or purchase of a first car without a loan, all could be wise investments.


My high school and college summer jobs paid for my first car, and contributed to my first home down payment, I was certainly glad to have that money accessible in my 20s. It costs some real money to get your feet under you and running in life.

It's a lot less restrictive than you think. You can withdraw contributions at any time, and you can withdraw up to $10K for your first home down payment, and in cases of disability.

https://www.schwab.com/public/schwa.../understanding_iras/roth_ira/withdrawal_rules
is a good summary of when you can withdraw earnings penalty free, and in some cases tax free.

Essentially one can "loan" a Roth IRA the funds to grow for retirement, and then withdraw the principal and let the earnings continue to grow for retirement. That helps you get a start on retirement while leaving money accessible for your 20s. It's especially helpful when a parent or grandparent gifts the youngster the funds for the contributions. I'm doing this for my son.

 

[The Cosmic Avenger]

We do this as well.
Taxes don’t impact their earned income. I just look at the last paystub for the summer and then deposit that amount in the Roth.
No issues so far.

So you funded the Roth with a direct transfer from your own account? I wonder if that could trip you up if the IRS decided to be picky. I mean, that's probably what I would normally do, but I wonder if I should transfer our funds to their savings account, then from there to their Roth IRA. (I do manage their account for them at the moment as is their preference, although I've given them a card and online access.)

 

[The Cosmic Avenger]

Potential downside I see is that you and they are locking that money away in a retirement vehicle, inaccessible without penalties. You are starting to build their retirement savings account, but perhaps the best way to support eventual retirement is investment at this age rather than saving. Money that could go to college, or grad school, or pay of loans for either, or a down payment on a first home, or purchase of a first car without a loan, all could be wise investments.


My high school and college summer jobs paid for my first car, and contributed to my first home down payment, I was certainly glad to have that money accessible in my 20s. It costs some real money to get your feet under you and running in life.

Well, remember, this is a "bonus" we're giving them. They can still do that with the money they earn, we're just matching it to fund the Roth IRA. And we might still help them with those other things; we're planning on paying for at least undergrad without loans, or if there is a loan, to only use it as a convenient bridge for ourselves and pay it off for them.

 

[cathy63]

So you funded the Roth with a direct transfer from your own account? I wonder if that could trip you up if the IRS decided to be picky. I mean, that's probably what I would normally do, but I wonder if I should transfer our funds to their savings account, then from there to their Roth IRA. (I do manage their account for them at the moment as is their preference, although I've given them a card and online access.)

It really does not matter. There is nothing in the tax law that says you have to be able to prove it's your own money that's going into a Roth IRA. You just have to be able to show that the contribution was less than or equal to your compensation. Also, the IRS is definitely not wasting their limited funds on auditing teenagers who don't even earn $6K/yr.

You may have difficulty doing an electronic transfer from your own account to a Roth IRA in another person's name though. I tried to set this up for my daughter (who is over 18, so maybe it's different for minors) and Vanguard would not let me fund it directly unless we had paperwork notarized by both of us. They had no problem taking a check that was drawn on my account and signed by me as long as daughter signed the deposit slip, so that's what we did.

 

[RunningBum]

One more tip, as long as they're 14 or over (no kiddie tax), an even better way to do this is to gift appreciated holdings and have them sell them to put in the Roth. Assuming their income is small as in the OP's case, they will be at 0% LTCGs, and you've shed a future tax liability. It's a little more complex in that it requires another investment account for them, but I'd think you could keep it open with just a few dollars in a sweep account.

 

[mrWinter]

So you funded the Roth with a direct transfer from your own account? I wonder if that could trip you up if the IRS decided to be picky. I mean, that's probably what I would normally do, but I wonder if I should transfer our funds to their savings account, then from there to their Roth IRA. (I do manage their account for them at the moment as is their preference, although I've given them a card and online access.)

Yes, you are right and thanks for correcting, I forgot that you can take out contributions penalty free, so it's not all locked away. The earning at least are locked away. My point though is that maybe saving for something other than retirement is the best investment at this point in life, and if it's not retirement savings then there may be a better vehicle for those savings, 529, or regular after-tax non-sheltered funds. No right answer for all I think of where best to put that money.

 

[GreenER]

Our young adult daughter is working and going to school but has no tax deferred savings plan at her work. We wanted to help her get started on saving early, but we wanted her to have skin in the game, so we offered to match whatever she saves to her Roth yearly (up to 1/2 max) as long as she doesn't have employer matching available. She was so proud of herself when she was able to save for her Roth and report in toward end of year on her total to be matched. She set up her account at Fidelity and called for investing advice. It seems to have helped motivate her toward saving and she says she's also been inspired by our early retirement. I feel good about helping her to learn how to save rather than just doing it for her. She has also admitted that she's more careful with what she's had to produce on her own than the things she was given when still fully supported. Like most teens she trashed a lot of things we bought for her. I think she's maturing! Can I hear a hallelujah! Now when we give cash for birthdays/ holidays she can double down if she chooses to save it rather than spend it. We aren't planning on making up the difference to bring her to max funding each year as we think that would disencentivize her own saving. She's not yet gotten to max funding but I'm confident she will as she seems motivated.

 

[kgtest]

Better yet, put the kids on the payroll as soon as they are born. Marketing royalties for your business's Christmas cards. That's for the super privileged