Opening a kid's Roth IRA

[Nords]

This might be a new subject, but if someone's posted on it before then kindly point me there.

Has anyone started a Roth IRA for their kid?  Any lessons learned?

Among other articles, I've read up on the subject in Fairmark, Kiplinger, TMF (although outdated), and SmartMoney.  I've also spent some quality time on the IRS website with Circular E & Pub 926.

Let's skip over the hurdles of "It's the kid's money so they'll party with it" and "The kid won't get any college financial aid."  Those are good considerations but I don't believe that they apply to our particular situation.

As I understand it, if a kid has earned income then it (up to $4000) can be deposited into a Roth.  If the kid is under 18 then it's not taxable or subject to Social Security/Medicare withholding, Federal unemployment tax, or self-employment tax.  Near as I can tell it's not subject to ANY taxes whatsoever, but I still need to research Hawaii's state tax issues. 

Documenting the earned income is as simple as cranking out a W-2, and again the employer doesn't have to withhold any Federal taxes as long as the kid is under 18. 

Is this deal too good to be true?  What am I missing?

 

[ESRBob]

Nords,
After much himming and hahhing, my accountant got me clear wording on this issue following a thread on the old board back in April. Hope it helps. His bottom line is this is totally legal, your brother-in-law accountant need not flinch. It is just not that common unless people have sole proprietorships that earn money and employ their kids, where the sweet spot in the benefits of this approach seem to lie.

>snip
I went over all this with my accountant friend and think I have it understood now -- wrote it all out to be clear below. He made a point of saying that doing chores at the rental property could work, but has its own separate rules which I don't understand yet. For a family with mom and/or dad self-employed, here's how it works:


First, to fund a Roth IRA, the child must earn income. It will work best if you have your own profitable sole proprietorship, and can verifiably employ your child doing work for the company. Perhaps your child does filing, runs products to customers, cleans the office, does clerical work and mailings.

To maximize the benefit, aim to have the child earn, from you or other sources, at least $4,000 a year. If you are an S-Corporation or LLC, your child will need to pay regular social security and unemployment taxes, but if you are a sole proprietorship, these are waived for children working in the family company.

The child's low earnings will also be shielded from income tax, due to their standard deduction and the nature of the tax tables. These earnings, essentially all after-tax earned income, can then be used for their annual contribution to a Roth IRA.
>snip

 

[Nords]

Bob,

Thank you very much for taking the time to track this down. I've read the same things as your friend and he's even read the things that I didn't bring up in the post.

It seems that few ask the questions and even fewer actually do it. I've posted this in a couple places and it's all been met with "Hmmm... gee... I don't see why not?" If others had fallen across the third rail on this I think I'd have heard it by now. I've read nothing about IRS audit flags and I suspect the whole issue is still under their radar. It gives me a warm, fuzzy feeling to find a way for teenagers to put away tax-deferred investments that can be withdrawn without penalty for education costs & home down payments.

My brother-in-law & I tore this apart last week (he has 25 years in the business) and we think it'll work. (If it had even a whiff of danger he wouldn't have wanted to touch it.) We use sole prop on our rental property but of course child labor won't account for more than about 5% of the gross receipts and that's way under $4000. The rest of it works out to a couple hundred in labor a month, though, and I know teenagers on our street with almost that much in ALLOWANCE let alone earnings.

When I started doing my own taxes, I never would have expected that I'd be learning how to generate W-2s. Thank goodness for QuickBooks.

I think I'm gonna point the kid toward accounting, just like her uncle. Either that or the military... whatta choice.

We'll call Fidelity tomorrow and see how they feel about being IRA custodian for a minor.

 

[cute fuzzy bunny]

The choice is clear: Military Accounting.

 

[Nords]

The choice is clear: Military Accounting.

Oddly enough our neighbor up the street does that as a civil servant.

Come to think of it, he always does have a smile on his face...

 

[cute fuzzy bunny]

And why not? You're faced with what may be the ultimate in oxymorons. Properly documenting military intelligence.

 

[Nords]

Belatedly back on topic, I called Fidelity today (where most of our accounts are) to open a Roth IRA for a minor. They said they don't do that.

When I called Vanguard, knowing their recent reputation for customer service, I made it clear that I was asking them to be custodian of a minor's Roth IRA. They initially confused that with a UGMA/UTMA but later corrected themselves. They're planning to charge $10/year for the IRA's "index maintenance fee" and $10 the first year for an account balance under $5000.

This money is unlikely to be touched for at least a decade and I'm looking for a small-cap value index. I know that Vanguard has some of the world's cheapest and possibly best funds but their customer service complaints concern me. While I could start an IRA with VISVX it's not much cheaper than the equivalent ETF (IJS).

I'm mainly following Bernstein's statistics but I feel that diversification, REITs, large caps, bonds, and commodities are inappropriate at this stage. UTMA funds already include international (Tweedy, Browne) so I'm not putting further money there. At this point the two biggest issues are expenses and reliability.

I've spent the last two decades mainly with Fidelity and Tweedy so I'm not very familiar with other fund companies or brokerages. Any other companies, brokerages, or funds worth considering?

 

[TromboneAl]

So, who's giving better answers to this: us or the people on Vanguard Diehards?

Is this for your kid or a nephew/niece?

I've thought about a Roth for my daughter. It sure is attractive: money in an aggressive investment compounding for 50 years!

But I decided not to do it.

1. College saving more important. But I will say that a Roth might be a clever way to save for college. Not taxed, and financial aid doesn't look at retirement funds -- though I bet they've never encountered a kid with a retirement fund.

2. It's enough that I'm paying for her college. I don't need to also be funding her retirement or later-in-life expenses.

3. If the kid is responsible enough not to use the money immediately, he/she is probably responsible enough to save money on his/her own.

What I'm considering doing is this: on my daughter's 18th birthday (in a year), I'll offer to match up to $500 for a Roth account. I think she'll go for this, since we've had a lot of investment talks, and she recognizes the power of compounding.

But I'll wait and see how things go with the college stuff. One thing I've found is that at this point, her money and mine are, in a sense, the same thing. For example, if she puts $500 into a Roth, that will just mean that I will be spending $500 more on college tuition. So it will really just be me putting $1,000 into the Roth.

But one benefit of having the Roth for her is that it makes it easier, at least psychologically, for her to send in some more money, since the account is already there.

Can you tell us more about your reasons for creating the Roth?

 

[yakers]

I have thought about the Roth a good bit. I expect to have my soon to be 16 year old open one when he gets a job. I had a UGTMA account which I closed out and now have the money in a Credit Union account. The fund was too volitle and he is approaching college. I would have him transfer money from the CU to the Roth to make it less visable as an asset for financial aid. Normally retirement funds are excluded from the resources considered for support. I understand private colleges can look at anything they want. And I expect that as Roth get larger and more common their financial aid status may change. I will have a better idea of my son's school costs in the next year or two and I will adjust when I know whether he goes to a local school or a Stanford.
What I have been doing is saving more funds in my own name.
Now for my new grandaughter I am setting up a DRIP account. I figure it will be a long time before taxes will be an issue and it will give her folks some flexibility in that they are establishing a 529 account as well.
There really is no simple, automatic way to go. I do not find the Roth compelling for a really young person as I think flexibility will be more important. But if the young person actually had a job (acting or whatever) then it may be a good place to put their money.

 

[ESRBob]

Had a brainwave on what a sole proprietorship could hire a kid to do that could reasonably eat up 4k a year in legitimate expenses: have them build, modify and maintain a website for the enterprise, as well as look after computer equipment. Not only does this feel legitimate, it also teaches your kid useful skills they could go outside and earn money with, too. Come to think of it, would be even better to give your kid $1000 a year and have them go earn 3k a year doing web design etc. for other people, and making up the minimum earnings that way.

Since you are whisking their hard earned cash away from them so mercilessly, you could offer to buy them a cool new Zire or iPod or something. Or just tell them that money is for saving, not for spending. Whatever works.

Nords, I think you're on solid ground. I'll be doing this myself by next year -- trying to get the 8th grader started earning money for me somehow -- so far he is doing a good job of resisting all my best efforts to wean him from his hobbies and get the harness over him, but we'll keep trying.

 

[cute fuzzy bunny]

I called Fidelity today (where most of our accounts are) to open a Roth IRA for a minor. They said they don't do that.

They're planning to charge $10/year for the IRA's "index maintenance fee" and $10 the first year for an account balance under $5000.

My orneriness would have me moving my money from the company that 'dont do that' to the one that does, in which case your combined family assets would also save you the maintenance fees on the kids accounts.

Also, have had zero trouble with vanguards customer service. In fact, I simply havent had much need for it. When I have had the need, a nice flagship person is available to me on an 800# or by email, takes my question, and gives me a reasonably decent answer within a day or two. Most of my questions have been about their odd terminology (funds = accounts) or quirks and small bugs in their web site. Everything else I've done online with only some quirks.

Possibly if you're not a voyager or flagship customer you get some guy in india thats just waiting for you to call him a 'paki' because you're angry that your jobs are going away.

 

[ESRBob]

Nords,
I have the same experience with Vanguard as TH -- nothing wrong that I've ever noticed, and I've been with them 20 years. Just talked to the Flagship person today (I was actually trying to get the standard deviation of the Wellington Fund, somehting greater than the 10 year numbers Morningstar has) and they were very pleasant and responsive (but still not data, hope to have it tomorrow).

You may have some sample bias -- people with an ax to grind usually make more noise. Gee, who would ever post anything here if no one had an ax to grind?, but I still wouldn't let those people's experience put you off. Worst case you make a few more phone calls or wait another week for some piece of paper or statement. Vanguard's products are (generally) really great, imho.

 

[Nords]

So, who's giving better answers to this: us or the people on Vanguard Diehards?
Is this for your kid or a nephew/niece?
I've thought about a Roth for my daughter.  It sure is attractive: money in an aggressive investment compounding for 50 years! 
But I decided not to do it. 
Can you tell us more about your reasons for creating the Roth?

Man, I'm beginning to regret posting at the Diehards.  I've had good advice there in the past but this question seems to have shaken a nut or two out of the tree.  I've also posted at Ed Slott's board but neither their CPAs nor my brother-in-law the CPA have ever heard of anyone attempting this.  (He sees a lot of high-income taxpayers.)  So I think the Vanguard crowd just doesn't know what to say about the situation (or they don't have school-age kids).  No doubt they'll be ready to tell me just what funds I should buy.  And as I get closer to picking a fund then I might also post at FundAlarm.

But here's the concept.  It's for our 12-year-old kid.  Our college savings are on track in a small UTMA and we've held a few of our Berkshire-Hathaway shares in reserve (still parent's money).  I think college is fully funded as far as parental consciences are concerned.  I'll help with scholarship searches but the rest of that is up to the kid.  She's been a straight-A student so far (purportedly by being born to the world's meanest parents) and it'll be interesting to see how that survives the next five years.  Besides I can always introduce her to my good buddy at the Navy Recruiter's office.

I would have expected that colleges would count Roth contributions against their students' financial aid.  But as you say, I don't think they have much experience with it and it's a great loophole.  The nice thing is that, if desire exceeds funds, she can tap into the Roth without a penalty but yet with taxes.  The nicer thing is that we don't have to pay for those credits in underwater basket weaving and she'll have her own assets at stake before she's overly generous with her money (instead of ours).  Tapping a Roth requires a deliberate decision (and more income tax) than just whipping out Dad's credit card, and it's good practice for later in life when other Roth-tapping situations arise.  The earlier she practices these risk-reward decisions in our household, the better she'll do when she moves out.

She's starting to show the beginnings of interest in saving for college and we want to fuel that feeble flicker.  Right now it's mostly caused by watching Nickleodeon sitcoms & commercials but hey, it's a start.  Like most of us I saved some of my teenage job money for a few years in a passbook savings account and it was drunk gone about 18 months after matriculation.  (Wait'll I tell her about her genetic susceptibility to alcohol poisoning.)  I agree with you that the earlier she starts thinking about putting that money aside, and the easier it is, then the better it'll work.  When her money-grubbing instinct resurfaces I want to be able to say "How 'bout putting it in your Roth IRA?" and hopefully it'll be a little slower to squirt right back out of her pockets again... 

I agree that we don't need to be funding the kid's retirement or other expenses and I'm mildly concerned about TMND's Economic Outpatient Care.  One day this may backfire on us and we may have to say to her (or her significant other!) "Didn't we put that money in your Roth IRA for just this sort of situation?  Remember, withdrawals are taxable.  Good talking with you, call again soon!"  Ideally this Roth IRA will compound in complete neglect despite the pressure of homes & graduate schools (or just raising a family).  But there are mitigating factors:
- Ya gotta know your kid.  Ours seems amenable to LBYM despite heavy peer pressure.  She's aghast at the cost of Roxy while she enjoys bragging about shopping at Goodwill.  Last month she got the gimmes for an iPod but, after some experimentation & consumer education (and a few tears), she shopped hard for a $10 CD player.  I think she gets it.
- Hawaii's home prices are high but apparently sustainable.  If it's a choice of jump-starting a Hawaii home purchase in 10-15 years or of flying to the Mainland to visit our kid, then I'd rather start charging the battery now.
- The kid has abandoned the sport of dressage, which sucks money out of one's pocket almost as fast as owning a boat.  So we have a little slack in this year's budget, my spouse had had some P/T work, and we'd hate to lose a compounding opportunity.  Next year may not be as flexible.  Some money today is feasible, who knows what tomorrow's budget will support.  Tax-free compounding makes it even better than the prospect of more at a later date.
- The kid is arguably (er, to the IRS, negotiably) old enough to perform rental-property management chores (painting, lawn care, bill paying, tax forms) and household domestic slave labor.  (Gosh knows I could use a teenager who can swing a paintbrush and a chainsaw.)  Of course she'll continue to swab toilets, haul trash, set the table, prepare meals, and clean her assigned field day spaces just for the awesome privilege of being a member of this family.
- It seems like a good way to encourage learning home maintenance/repair skills.  She used to rake leaves & cut grass because Grandma & Grandpa appreciated the help.  Now motivation isn't so easy, and instead of the labor just putting money in her pocket for yet another Jamba Juice, this could make her feel like she's helping herself to pay her college bills.  I'll do any amount of subsidizing to encourage that independence.
- This eliminates all her pressure & resentment over having a personal car.  (Not that we were ever buying her one in the first place!)  When the other rich kids (of poor parents) say "How come your parents didn't buy you a car like mine?" she'll be able to defend her peer status with "Because they're putting my earnings in a Roth IRA for college and a home down payment."  That immediately goes on the kid's gossip network ("Hey, Mom, guess what her parents are doing!") and starts many of our interesting conversations with our neighbors.  I'd be a hypocrite if I claimed that I didn't enjoy that.

But I'll wait and see how things go with the college stuff.  One thing I've found is that at this point, her money and mine are, in a sense, the same thing.  For example, if she puts $500 into a Roth, that will just mean that I will be spending $500 more on college tuition.  So it will really just be me putting $1,000 into the Roth.

But one benefit of having the Roth for her is that it makes it easier, at least psychologically, for her to send in some more money, since the account is already there.

Bottom line is that today we can do something nice (yet educational) to prepare her for her future.  That may not be as achievable in later years and the compounding opportunity will be gone forever.  I especially agree with your thoughts on helping fund her Roth IRA instead of her just spending our money, and of making it easier for her to keep funding it!!

Had a brainwave on what a sole proprietorship could hire a kid to do that could reasonably eat up 4k a year in legitimate expenses:  have them build, modify and maintain a website for the enterprise, as well as look after computer equipment.  Not only does this feel legitimate, it also teaches your kid useful skills they could go outside and earn money with, too.

Go#&^@% it, Bob, I was saving that one for the IRS' Regional Revenue Office!  She started making websites in her sixth-grade class and with today's software & free websites it's a lot easier than in the mid-90s.  So keep it under your hat... otherwise she'll be duking it out on Google searches with TH's kid.

But I still have one other idea. 

Since you are whisking their hard earned cash away from them so mercilessly, you could offer to buy them a cool new Zire or iPod or something.  Or just tell them that money is for saving, not for spending.  Whatever works.

David Owens claims in one of his books that "saving for college" is light-years away from a kid's psyche.  Parental attempts to encourage that cause them to question adult sanity and, even worse, to splurge the money as quickly as possible to avoid having it repossessed for "savings".  So it might not be successful with more than a few hundred $$... but every compromise helps.

 

[Nords]

My orneriness would have me moving my money from the company that 'dont do that' to the one that does, in which case your combined family assets would also save you the maintenance fees on the kids accounts.

Also, have had zero trouble with vanguards customer service.  In fact, I simply havent had much need for it.  When I have had the need, a nice flagship person is available to me on an 800# or by email, takes my question, and gives me a reasonably decent answer within a day or two.  Most of my questions have been about their odd terminology (funds = accounts) or quirks and small bugs in their web site.  Everything else I've done online with only some quirks.

That's the kind of attitude that caused us to "fire" Tweedy, Browne as our IRA custodians.  But bad customer service there had a lot to do with it too and I'm a little gunshy.  We still get treated pretty good with Fidelity (at least as soon as our account data hits their screens).

I have the same experience with Vanguard as TH -- nothing wrong that I've ever noticed, and I've been with them 20 years.

You may have some sample bias -- people with an ax to grind usually make more noise.  Gee, who would ever post anything here if no one had an ax to grind?, but I still wouldn't let those people's experience put you off.  Worst case you make a few more phone calls or wait another week for some piece of paper or statement.  Vanguard's products are (generally) really great, imho.

My sample bias come's from Dee Havens' deposition about Vanguard's aggressive consolidation tactics and their cluelessness on IRA beneficiary directives.  If she has an axe to grind then Vanguard has earned the distinction of being the world's biggest wheelstone.  But if you & TH can get along with them then I don't think that I'll have any problems.  And with this tiny IRA balance, I know I won't have to worry about getting a free GE appliance just for signing up!

Good thing this is earned income.  Vanguard said that if the application came from the kid (with a parent's signature) but the money didn't come from her account, then they'd need her gold medallion signature guarantee to open the account.  I guess they're just afraid to take candy money from strangers...

 

[cute fuzzy bunny]

All I know is, if GE owned a brokerage or sold funds, they'd suck. (hmm...maybe they do and I just dont know the connection?)

A big question that landed on me while I was dumping the diaper genie that maybe you've asked and answered...whats the legal age to "work" in hawaii and therefore receive a w2...I remember it was something like 15 in Mass. or 14 if you had some kind of 'work permit' that basically was some bureaucrat asking you if you were being forced into child slave labor or not. It may be that your kid cant legally 'work' until she's 15 or 16...?

 

[Nords]

whats the legal age to "work" in hawaii and therefore receive a w2...I remember it was something like 15 in Mass. or 14 if you had some kind of 'work permit' that basically was some bureaucrat asking you if you were being forced into child slave labor or not.  It may be that your kid cant legally 'work' until she's 15 or 16...?

"Legal" work age?!? Those laws would've been a big help when I was growing up!

Hawaii's age 14 for a work permit. That's a good point about whether we can pay her before then, and I still have to (*sigh*) research state taxes. Fed standard deduction takes care of those taxes but Hawaii may not be so charitable.

 

[cute fuzzy bunny]

I just found the pertinent docs. A child may work for a parents 'business' at any age.

However, there are some possibly applicable minimum hourly rates that apply for certain ranges of work and some types of work a child cannot do.

And yes, state laws are different.

" What is the youngest age at which a person can be employed?
The Fair Labor Standards Act (FLSA) sets 14 as the minimum age for most non-agricultural work. However, at any age, youth may deliver newspapers; perform in radio, television, movie, or theatrical productions; work in businesses owned by their parents (except in mining, manufacturing or hazardous jobs); and perform babysitting or perform minor chores around a private home. Also, at any age, youth may be employed as homeworkers to gather evergreens and make evergreen wreaths.
Different age requirements apply to the employment of youth in agriculture.
Many states have enacted child labor laws, some of which may have a minimum age for employment which is higher than the FLSA. Where both the FLSA and state child labor laws apply, the higher minimum standard must be obeyed.
Must young workers be paid the minimum wage?
The federal minimum wage is $5.15 per hour. However, a special minimum wage of $4.25 per hour applies to employees under the age of 20 during their first 90 consecutive calendar days of employment with an employer. After 90 consecutive days of employment, or when the worker reaches age 20 (whichever comes first), the Fair Labor Standards Act (FLSA) requires employers to pay the full federal minimum wage of $5.15 per hour.
Other programs that allow for payment of less than the full federal minimum wage apply to workers with disabilities, full-time students, and student-learners employed pursuant to sub-minimum wage certificates. These programs are not limited to the employment of young workers."

 

[ESRBob]

Nords,
Just poicked up a copy of Kiplinger's Retirement Special Edition on the newstand and they have a good article about kids Roths, totally supporting and promoting the idea. Totally legal and above board, and a prominent tax bigwig blessing it. Funny they mention that almost all the fund houses except Fidelity will do this. Vanguard apparently quoted for the article that it is one of the best things you could ever do for your kid.

Hope this helps. If you like, PM me and I can fax you the article.

 

[Nords]

Bob, thanks for the fax.

In the "Well, duh" department I didn't think far enough through the project to realize that a W-2 is only necessary for business income.  Money paid for jobs around the house, babysitting, and dogwalking doesn't have to be documented on a W-2.  (But should probably be documented with other records.)

I wonder what the IRS does when a Roth IRA contribution is reported via Form 5498 and it doesn't have a matching W-2.  More research!

 

[KB]

Nords.....I think I may have answered this question before but I will again.

I opened a Roth IRA for my 16 yo son a few years ago with Vanguard. Because of something I had read, I sent in my son's taxes showing 2400.00 income without a W-2 or any specific employer, and with the 2400.00 Roth IRA purchase. Since the 2400.00 is below what is required to submit to IRS, they sent me a nice postcard reply telling me that the income was too low to file and that we didn't need to file again with that level of income.

And that was that !! It was easier than I thought.

 

[retire@40]

I opened a Roth IRA for my 16 yo son a few years ago with Vanguard.  Because of something I had read, I sent in my son's taxes showing 2400.00 income without a W-2 or any specific employer, and with the 2400.00 Roth IRA purchase.   Since the 2400.00 is below what is required to submit to IRS, they sent me a nice postcard reply telling me that the income was too low to file and that we didn't need to file again with that level of income.

And that was that !!  It was easier than I thought.

Ignorance is bliss.  The IRS only said $2400 of income is lower than the minimum threshold to file.  They didn't validate everything else you stated.  That may not be that.

 

[KB]

OH.......

 

[cute fuzzy bunny]

Call the IRS 800#. They'll put you in touch with a nice irs agent that will answer your questions. Get his name and ID number and write down what he says, the date, time and his ID info.

 

[Martha]

Here is the IRS publication on when you must file a return for a kid: http://www.irs.gov/pub/irs-pdf/p929.pdf

If all the income is earned income, the 2004 cutoff was $4850.

 

[Martha]

I have a couple of thoughts on all of this. First, I'll bet that whether a ROTH IRA contribution can be based on income earned by a child from household chores, in contrast to income earned from a family business, is a gray area. No one ever seems to withhold income tax from wages paid to children for chores. Common sense (is there such a thing?) tells us that it really isn't taxable income. Therefore, the IRS could argue that either (1) it isn't income so no Roth contribution is allowed or (2) it is income, so where is your withholding, w-4 and w-2?

So I would guess there is a risk here. You might have a W-4 filed out, saying "exempt" (though I am not sure the income is exempt from withholding in the first year of employment) and issue a W2 showing no withholding.


As mentioned earlier, no worry about FICA etc.

Isn't it odd this has to be so complicated? I guess that is why it is uncommon.