Opinion Please: Did I make a mistake on kids IRA contribution?

[Aiming_4_55]

I waited until the last minute filing taxes as life happens, so I'm second guessing myself now. Here are the scenarios:

High schooler kid 1 worked all year and earned ~$31k and paid $2199 in Federal taxes on W-2. We contributed $6k to a traditional IRA to get more tax refund for her, about $720.

High schooler kid 2 worked part of the year and earned ~15k and paid $711 in Federal taxes on W-2. To get all taxes refunded, contributed $2295 to Traditional IRA. $3705 went to a Roth IRA.

In the future, they might reduce hours while in college when they could do a conversion. Small potatoes, but just felt better to get them a larger tax refund now.

Full disclosure: during Roth conversion, I'm pretty sure I'll cover the tax fees. It was interesting explaining tax returns and deduction to them . (They didn't care!)

 

[erkevin]

No significant error.

 

[MichaelB]

Nice to see young people working and earning. Not sure why you think this might be a mistake. I did similar with my kids, I opted for Roth instead of traditional IRA but their (my kids) tax rates were lower. I think either choice of IRA is a good option and far better than not making any retirement plan contribution.

 

[Montecfo]

Did not want to bury the lead: congrats on teaching young kids to work and earn. That will pay long dividends.

Your IRA strategy seems fine. Was there a concern?

 

[disneysteve]

If you’re willing to share, I’m curious what part time job earned kid 1 $31,000. That’s more than a full time minimum wage job. If they averaged 20 hrs/wk that’s $30/hr assuming some vacation time.

 

[Aiming_4_55]

If you’re willing to share, I’m curious what part time job earned kid 1 $31,000. That’s more than a full time minimum wage job. If they averaged 20 hrs/wk that’s $30/hr assuming some vacation time.

I'm a bit shocked as well for a 16 year old kid. It's a casual restaurant with dine-in within a middle class suburb, so tipping for good service is welcomed. Kid gets on co-workers when they slack, so very much a hard worker.
Unfortunately, a fair amount of people are bad tippers. Works 5 or 6 shifts (5 hour shifts) during the school year and full time during the summer/winter breaks. Kid maintains an A average and involved in one sport, so kid keeps busy. I have to ask when I can schedule 1:1 time... for a Dad/kid sushi night or movie!

 

[MarieIG]

I would get some money into kiddo #1's Roth. Think about the tax free compounded earnings over 50 years. If you "forget" about the conversions, you will leave the kiddos subject to the prorata rule for conversions later on, if they are unable to make direct contributions.

Good for you for thinking about the kiddos futures.

 

[RunningBum]

Tax-wise they are virtually certain to be in a higher tax bracket later so long term it would be better to contribute to a Roth now. They could withdraw $10K penalty free for their first home purchase, so long-term doesn't necessarily mean old age. But I understand cash is scarcer in their young ages so making more of it available now might be more important, and it's a nice reward for hard working kids who are keeping grades up. With kid 2 it looks like you made sure not to do a deductible tIRA contribution at 0%, which is the only real mistake that could have been made.

 

[Aiming_4_55]

I would get some money into kiddo #1's Roth. Think about the tax free compounded earnings over 50 years. If you "forget" about the conversions, you will leave the kiddos subject to the prorata rule for conversions later on, if they are unable to make direct contributions.

Good for you for thinking about the kiddos futures.

Yes, we discussed the power of compounding and having $$$ at 50 to determine how life can be FIRE. 2022 was the second contribution for kid 1, Roth was the easy option as kid made less. Already made/saved enough for 2023 so 3rd contribution is almost ready. Current employer does not offer 401k, so my goal is to leverage IRAs until first professional job where I hope a 401k program is available.

 

[Aiming_4_55]

Tax-wise they are virtually certain to be in a higher tax bracket later so long term it would be better to contribute to a Roth now. They could withdraw $10K penalty free for their first home purchase, so long-term doesn't necessarily mean old age. But I understand cash is scarcer in their young ages so making more of it available now might be more important, and it's a nice reward for hard working kids who are keeping grades up. With kid 2 it looks like you made sure not to do a deductible tIRA contribution at 0%, which is the only real mistake that could have been made.

After the rush of filing taxes and making a big tax payment, I agree and felt it was a small mistake, but I do plan to do the conversions sooner vs later. I'm thinking they may make less in college, so better time to make conversion. Added a calendar entry to review in Dec/Jan to review.

 

[ivinsfan]

I would get some money into kiddo #1's Roth. Think about the tax free compounded earnings over 50 years. If you "forget" about the conversions, you will leave the kiddos subject to the prorata rule for conversions later on, if they are unable to make direct contributions.

Good for you for thinking about the kiddos futures.

I feel like you are assuming alot with the 50 year comment. I wouldn't be a bit surprised to see the tax free earning part of Roth's disappear or be tied to income levels like SS.


I might favor the Roth strictly on the existing 5 withdrawal rule as that money vests it can become an emergency fund.

 

[SevenUp]

High schooler kid 1 worked all year and earned ~$31k....
High schooler kid 2 worked part of the year and earned ~15k....

Could you claim them as dependents or did one or both contribute >50% to their own support?

 

[SevenUp]

I might favor the Roth strictly on the existing 5 withdrawal rule as that money vests it can become an emergency fund.

Roth contributions "vest" immediately. Using Roth IRA as an emergency fund can be appropriate.

 

[MichaelB]

After the rush of filing taxes and making a tax big payment, I agree and felt it was a small mistake, but I do plan to do the conversions sooner vs later. I'm thinking they may make less in college, so better time to make conversion. Added a calendar entry to review in Dec/Jan to review.

I think your reasoning is sound. Even if their college earnings are higher, there’s no mistake here IMHO. Time will tell if a future conversion will be at a lower tax rate, but putting money into their retirement at this young age and helping them start to think about taxes and funding their retirement is never a mistake. Maybe a missed opportunity, but even that is a nit.

When I deposit into my kids IRAs I always go to the Roth, even when they’d rather it went into tax-deferred. I’ve read so many threads here about retired members unhappy with high RMDs and taxes in retirement it's left a lasting impression.

 

[ivinsfan]

Roth contributions "vest" immediately. Using Roth IRA as an emergency fund can be appropriate.

Perhaps the word vest is a little misleading. Withdrawing your actual contribution amount doesn't give you any more money then you have to begin with. The earning have a completely different set of rules..Which is what I was trying to post. There are more rules then you think for withdrawing from a Roth. For younger people it's a bit more restrictive then I realized. However for the OP's kids I'd go with the Roth....

 

[copyright1997reloaded]

Roth contributions "vest" immediately. Using Roth IRA as an emergency fund can be appropriate.

This.

One of the bigger "hidden" advantages of a Roth over a tIRA is that contributions (but not earnings on them) can be taken out at any time without penalty or any taxes (regardless of age).

This makes them a good vehicle as a true emergency fund (as opposed to what my DC considers an emergency).

ETA: My DC, who was an authorized user on one of my credit cards, decided that being hungry at 11:30PM constituted an emergency, and used the credit card at Taco Bell. I had to further "explain" emergency as being either dead, dying, arrested, likely to be arrested, killed/kidnapped/unsafe situation.

 

[ivinsfan]

Tax-wise they are virtually certain to be in a higher tax bracket later so long term it would be better to contribute to a Roth now. They could withdraw $10K penalty free for their first home purchase, so long-term doesn't necessarily mean old age. But I understand cash is scarcer in their young ages so making more of it available now might be more important, and it's a nice reward for hard working kids who are keeping grades up. With kid 2 it looks like you made sure not to do a deductible tIRA contribution at 0%, which is the only real mistake that could have been made.

And if they do buy a home after holding the Roth for over 5years the money is penalty and tax free 10K

 

[SevenUp]

There are more rules then you think for withdrawing from a Roth.

The Treatment of distributions summarized in table form is a good start.

 

[ivinsfan]

This.

One of the bigger "hidden" advantages of a Roth over a tIRA is that contributions (but not earnings on them) can be taken out at any time without penalty or any taxes (regardless of age).

This makes them a good vehicle as a true emergency fund (as opposed to what my DC considers an emergency).

ETA: My DC, who was an authorized user on one of my credit cards, decided that being hungry at 11:30PM constituted an emergency, and used the credit card at Taco Bell. I had to further "explain" emergency as being either dead, dying, arrested, likely to be arrested, killed/kidnapped/unsafe situation.

Of course you don't have to pay taxes on what you originally put in the Roth you already payed the taxes on that money...if you can wait five years you have a lot more options on the table...

 

[ivinsfan]

The Treatment of distributions summarized in table form is a good start.

Not a fan of wiki for financial info ..I've been looking at the IRA site and Charles Schwab.. A little OT but in the case of high school students important to think when they might need extra money in the future. For example the Schwab site tells me you can take earnings penalty free ( but not tax free) before the 5 year mark if they are used for qualified education expenses.

 

[Aiming_4_55]

Could you claim them as dependents or did one or both contribute >50% to their own support?

Both are claimed as dependents for now. When I RE next year or so, it'll be less important to me and they can take the deduction if my thinking is correct. I just turned 54 and been FI for a few years, so I've been OMY and still aiming for 55 to retire. If I retire next year after RSU/Bonus in April, I will probably want the deductions, but starting 2025 the deduction will be less important to me.

 

[disneysteve]

I'm a bit shocked as well for a 16 year old kid. It's a casual restaurant with dine-in within a middle class suburb, so tipping for good service is welcomed. Kid gets on co-workers when they slack, so very much a hard worker.
Unfortunately, a fair amount of people are bad tippers. Works 5 or 6 shifts (5 hour shifts) during the school year and full time during the summer/winter breaks. Kid maintains an A average and involved in one sport, so kid keeps busy. I have to ask when I can schedule 1:1 time... for a Dad/kid sushi night or movie!

Fantastic! Good for them. They'll go far in life and starting their retirement accounts now will pay off big time down the line. I had my daughter start her Roth at 16 also with her babysitting money. Nothing like 5 decades of compounding magic.

 

[cathy63]

Both are claimed as dependents for now. When I RE next year or so, it'll be less important to me and they can take the deduction if my thinking is correct. I just turned 54 and been FI for a few years, so I've been OMY and still aiming for 55 to retire. If I retire next year after RSU/Bonus in April, I will probably want the deductions, but starting 2025 the deduction will be less important to me.

Unless they are spending their income to provide more than half their own support, you can claim them as dependents for any year when they are under age 24 and in school for at least part of 5 calendar months. Income they put in savings (IRA, Roth or other) is not counted towards support. Scholarships are also not counted.

If your AGI will be less than $80K ($160K if MFJ) while they're in college, then you should almost certainly continue to claim them. You as the parent are eligible for education credits that the students can't claim on their own returns.

 

[SecondCor521]

I would have recommended any contributions go to a Roth. Yes, they'll pay 10%/12% taxes now, but I consider that a good deal compared to what they'll pay later. But any retirement contributions now are fantastic.

Keep in mind the retirement savings contribution credit on Form 8880. I don't think they can claim it if a dependent, but there may be a college year in there somewhere where they are relatively low income, have the money to make the contribution, and qualify for the credit.

Either the student or the parent can claim the education credits if AGI below $80K/$160K. However the student will probably not qualify for the refundable portion of AOTC. So it's usually better to have the parent claim the child and the AOTC if AGI is below the limits (and the kid otherwise qualifies, which most do). You can read up on most of the education tax benefits in general in IRS Pub 970.

 

[MarieIG]

I feel like you are assuming alot with the 50 year comment. I wouldn't be a bit surprised to see the tax free earning part of Roth's disappear or be tied to income levels like SS.


I might favor the Roth strictly on the existing 5 withdrawal rule as that money vests it can become an emergency fund.

Check back then in 50 years. Otherwise, I'm standing by my comment.