Have you heard about the life-changing benefits of a Roth IRA for kids? It's essentially an investment account that allows you to invest for your children's future retirement needs with their earned income.
Dee from Kids Money Academy shares why a Roth IRA for kids is so great and how to hire your kids in your business. This is how generational wealth happens!
What is a Roth IRA for Kids (or a Custodial Roth IRA)?
A Roth IRA for kids or a custodial Roth IRA is a special type of retirement account for minors. Dee says it's similar to a Roth IRA for adults, but there are more rules around it.
Understanding Earned Income
Roth IRAs for kids don't have any age limitations or minimums. Instead, they have to meet the requirement of having earned income. Your child needs to make money. That money also needs to come with a paper trail so that you can prove to the IRS that they are earning money legitimately.
What doesn't count? Birthday money, spending money, or money that you pay your child for chores around the home would be hard pressed to qualify as earned income.
In the event of an audit, having evidence of earned income really matters–to your family and to the IRS!
Evidence that shows it is a legitimate income might look like a something as simple as spreadsheet. This might chronicle hours of where they babysit, who they babysit, and how much they are paid. If your child makes more than $400, filing income taxes is another way to show that their money is earned income.
Other Things to Know About Roth IRAs for Kids
After meeting the earned income requirements, a Roth IRA for kids functions similarly to a Roth IRA that you might already have! You can't contribute if you earn more than the IRS income limits allow. And if your income does make you eligible to contribute, you can't contribute more than the contributions maximums for the year.
One final consideration to make with Roth IRAs for kids is that you can't add more to their account than what they actually earn. Let's say the Roth IRA contribution limit for the year is $6,000. If your child earns $1,000 in income for the year, you can't add another $5,000 (or $500 or even just $50 to it). Kids and teens can only contribute up to the amount of income they earn each year!
Why It's Important to Invest Early in a Roth IRA for Kids
One of the first thing Dee points out is how time works in your favor when it comes to a Roth IRA for kids. She says that if a child's family helps them open a Roth IRA for kids when they are 8, that is just shy of 60 years of growth potential (if we use 65 as a typical retirement age).
“When did we start our Roth IRA?” she asks. Compare your answer to what 57 years of accumulation might look like for your child. That's nearly 60 years of letting compounding work its magic.
It's no wonder that people like Certified Public Accountant Logan Allec say Roth IRAs are one way to make your child a millionaire.
Logan points out that there are plenty of ways to help your child get started on the right foot in adulthood. 529 college savings plans and UTMAs are some options. However, Logan also says, “If you are really looking to set up your child when he or she is in her 60s or 70s, the Roth IRA is the smart choice.”
That's because the money in a Roth IRA is set aside for retired or select other purposes. However, when it comes to UGMA or UTMA accounts, kids can spend that money on anything they'd like once they become legal adults. It's true that some kids may continue to invest that money or spend it on education. However, there's nothing stopping your young adult from spending it all on a trip to Vegas either (except for the financial values you already instilled in them, of course!).
Hiring Your Child to Start a Roth IRA for Kids
You might be wondering if it's possible for you to hire your child to kick off this generational wealth building strategy. It is possible to hire your child to help them start a Roth IRA for kids. However, this is more than just paying your child for chores!
Remember that a custodial Roth IRA requires earned income. That means that if you are going to hire your child, you now need two paper trails. Your child need to be able to prove that they brought in an income. In turn, you need to account for paying your child. That might mean making them an official employee of your business or hiring them as a contractor. Either way, that entails recordkeeping and could have legal and tax consequences for you and your business.
Deciding on a Reasonable Wage
If you decide to hire your child, Dee says you want to make sure you are paying a reasonable wage. For example, she says, “If your child is modeling for your business, look at different modeling agencies and inquire about pricing from them.” You want to gather the most accurate and up-to-date information. After you discover the market rate for the job, save it digitally or print a copy. Then, you want to put these recordswhere you store all of your child's employment information.
Getting Creative with Hiring…The Legal Way!
Let's imagine that you are a small business owner, but your child can't do the same job as your other employees. They can still qualify for a Roth IRA for kids!
The first thing to remember is that you can't hire a child to do any of the jobs that are too dangerous for kids. Still, if your small business revolves around one of those jobs, Dee suggests thinking about what your child can do behind the scenes. Perhaps your child can help with marketing, social media, web design, email communication. Even if you own a construction business that doesn't rely on much by way of technology or marketing, you can still employ your child. You might hire them to do a task like washing company cars!
What If My Kid Doesn't Qualify for a Roth IRA for Kids Right Now?
As you listen to Dee, you are likely wondering what to do if your child doesn't qualify for a Roth IRA. The first thing to do is simply accept it! Just like not all adults are eligible to grow income in every way possible, the same is true for our kids and teens.
However, both Dee and Logan Allec point out that there are plenty of other ways to help kids learn to manage their money. Logan says that families can start with an allowance at home. An allowance lets kids to make money mistakes.
Why is that so significant? As we all know as adults, we often learn more from our mistakes than our successes. More so, allowing kids to make money mistakes while they are young means that the mistakes have little consequence. It might sting to see them waste money. But $20 worth of buyer's remorse at 10 can set them up for success later in life!
Final Thoughts on Roth IRAs for Kids
Sometimes people get so excited at the thought of a Roth IRA for kids, they forget that there are plenty of other ways to build generational wealth, too. If your child doesn't currently have any earned income, you can't open a Roth IRA for kids. However, when they get their first job, you can help them set up this account.
In the meantime, explore your other options! Teach them financial literacy through books or include them in household financial discussions (as appropriate of course!). You can also open a high yield savings account for them or even set up a taxable brokerage account for kids!
When you're ready to take advantage of everything that a Roth IRA for kids can offer your family, make sure you check out Dee's course at the Kids Money Academy! You'll be working together to build generational wealth before you know it!
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Guest Bio – Dee from Kids Money Academy
As a CPA and Finance Instructor at UCLA, having conversations with other adults about money comes naturally to Dee. She founded Kids Money Academy to fill a huge need that empowers parents from all backgrounds to talk to their kids about money in a positive way.
Kids Money Academy answers the question, “How can I teach my kid about money in a fun and simple way?” by providing a framework that shows parents HOW to have conversations about financial literacy with their children from age 4 to 18 years old.
Resources – Dee from Kids Money Academy
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What do you think of the advice from Dee from Kids Money Academy? Are you looking to open a Roth IRA for kids?
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