Hiring your children in your business is a big tax benefit in itself.
Once you hire them and they are making earned income, they now pass the rules to open an IRA to start saving for their retirement.
Think about that for a minute…If your parents had made it possible for you to start putting away money into retirement as a child, how would that have changed things for you today?
I have asked myself this question and came up with a couple of answers. I would have been much closer to an affordable retirement then I am now and I absolutely know without a shadow of a doubt that I would have been more financially responsible.
Why do I know this? Because I have done this with my daughter and she, at 18, is far beyond understanding and respecting the dollar, then I was her age.
2013 IRA Contribution Limits:
As long as an individual has earned income, regardless of age, they can open up the IRA account and each year they can put up to what they earn with a maximum contribution limit of $5500, into the IRA. (Investment and passive income does not count)
IRA Contribution Deadlines:
The contributions deadline is the year’s tax filing deadline (i.e. Your daughter or son starts work in 2013. They will have until April 15, 2014 to make the contribution to her IRA.)
Who Can Make Contributions to the IRA?
Another good thing to know about the contribution for planning purposes is that the child does not need to make the contribution. As long as they have the earned income you, as the parent can make the maximum allowable constitution, but remember that it will still be claimed on the child’s tax return.
Types of IRA’S:
There are two different IRAs that your child can set up as long as they meet that earned income rule.
A Traditional IRA:
This IRA allows the individual to put away earnings tax deferred until they withdraw the money for retirement which is currently at 59 ½. If they decide to do an early withdraw then there will be a 10% penalty (unless there is a qualifying reason) on top of the individual’s current tax rate.
Pretty simple right? This is a good choice for those who want the tax free benefits now, but… don’t jump into this one to quickly as now is not always better.
A ROTH IRA:
This IRA does not allow the individual to deduct the contribution in the year that they make it. So no big bang now but the ROTH has some other benefits that might be better depending on your situation. If the individual waits until retirement age of 59 ½ all withdraws are completely tax free, even the earnings on the original contributions. If the individual needs to do early withdraw, they can withdraw the original contributions without penalty or tax for any reason. This is great in case of an emergency but not so great if they feel like it is some extra play money. If they withdraw the earnings before retirement then there will be a 10% penalty (unless there is a qualifying reason).
How to Withdraw Money Penalty Free from an IRA?
As I mentioned above there are qualifying reasons for waiving 10% penalties in either IRA.
- Paying for their qualified college expenses
- Paying medical expenses greater than 7.5% of their adjusted gross income.
- Paying for a first-time home purchase (currently up to $10,000).
- Paying for the costs of a sudden disability.
Which is Best, a Traditional or a ROTH IRA?
In looking at the 2 choices above, I would say there is a bit of planning to do right?
Some things to review before making a choice:
What is your child’s tax bracket? If their earnings put them in a 0-15% tax bracket a ROTH might be top choice. When else are they going to be at such a low tax bracket?
Are you afraid that they might just squander the money once they get control? Once you decide to put this plan into action, as soon as they are able to grasp the concept, it is absolutely imperative that you have a serious talk/threat council,with your kids about financial responsibility. If after you have the talk and you still feel nervous but you want to go ahead and do it anyway, then the traditional IRA might be a better choice with that 10% penalty as a possible deterrent.
They can set up both a ROTH and a traditional but the max contributions will still be their earnings up to $5,500 per year combined.
Where Should I go to set up an IRA?
When opening up IRA’s it is best to shop around to get a good Idea of your choices of mandatory start up contributions and investment options. If you have a financial planner already they are a great start, if not your local bank or some of the popular investment services such as Charles Schwab, which has a great start up IRA for kids with a minimum contribution of $100.
Keep in mind that this is such an underutilized benefit that I have found that some uneducated reps for the companies may say that there is no such thing as a IRA for kids. Rather than saying, “Hmmm, I have not heard of such a thing”, and getting you to someone who does know, they will just say it does not exist.
Are There Any Negatives in My Child Setting up an IRA?
If there is a possibility that your child will file for financial aid for college then the IRA’s, because they are in their name, will be considered in their application.