HIRE YOUR CHILDREN AND HELP THEM SAVE
Hiring your teenage children to work in your business can give them valuable employment experience and teach them to handle responsibility. Plus, if you can persuade them to deposit at least part of the money they earn into a Roth Individual Retirement Account (IRA), this can also give them a head start in saving for their future.
Because children seldom make enough to owe tax on their income, they may be better off with a Roth IRA than a tax-deferred traditional IRA. In 2015, your child is allowed to contribute $5,500 (or his or her earned income, whichever is smaller) to a Roth IRA. Contributions are nondeductible, but potential earnings and qualifying distributions are tax free.
A Roth IRA offers the greatest growth potential if the account is left untouched until the holder reaches the age of 59½. At that age, the holder can withdraw earnings tax free without penalty, provided the account has been owned for five years. Although the IRS does permit penalty-free Roth IRA withdrawals to pay for education or to help with a first-time home purchase, taxes are owed on nonqualified early withdrawals.
Before you open a Roth IRA for your child, keep in mind that you cannot stop your child from withdrawing money from the account whenever he or she wants after reaching the age of majority, which is 18 in many states. If you are uncertain about your child’s ability to manage money, opening an account in your child’s name may not be the best choice.
In addition, only taxable compensation income can be sheltered tax free in a Roth IRA. Generally, paying your children for doing chores around the house does not qualify as compensation income, as this is an intrafamily transaction usually not reported to the IRS. As a business owner, however, you are permitted to hire your minor children to perform certain jobs. As long as you pay your children a fair market wage for the services they perform, the money they earn can be considered compensation income and be invested in a Roth IRA.
It is essential to keep detailed records of how the money contributed to a Roth IRA was earned, even if a teenager’s working arrangements were informal and he or she did not earn enough to owe income tax. If the IRS determines that the funds deposited in a Roth IRA were not matched by compensation income, severe penalties could apply.
Your toughest task may lie in convincing your adolescents to save, rather than spend, their earnings. The good news is that, even if your teenager goes out and blows his paychecks on a new smartphone and skateboard, all saving is not lost. If, for example, your son earned $2,500 over the summer but spent all the money, you could still contribute the amount equivalent to his taxable earnings into a Roth IRA on his behalf, thereby helping to ensure he has something set aside when he retires and his skateboarding days are behind him.