It’s Finance Fridays again… did you know you there is a Roth IRA for Kids?
Stock Photo from: Pexels
So in previous posts I’ve talked about Roth IRAs and Backdoor Roth IRAs. I’ve even talked about the importance of utilizing a Roth 401k/403b in Residency. But what if we go way back into time, before medical school, before undergrad, before graduation… back to when you were 12 or 13 years old. You probably did some odd jobs around the neighborhood right?
For example, when I was a kid I used to babysit some kids down the street from me and wash cars. I used to tutor some younger kids in math, reading, and computers too.
I have no idea how much I made in any given year, but that is not really important, because the going rate for those things has likely changed.
Why does that matter?
What is important is that the 12 year old me could put have put away money without paying income taxes on the money I had earned, because I would likely be in the 0% tax bracket. Ideally, your child would have a W2, but the likelihood is that most 12 year olds won’t be working at a job that provides a W2.
Thus the onus is on your to demonstrate “earned income”. IRS Definition
For this reason you need to keep reasonable records which needs to include:
Work Type
Location
For Who
How Much
Now, that may sound tedious, but bare with me. Let’s say my daughter is now 12 years old and can start doing some work. She babysits once a month for my neighbor, walks the neighbor’s dogs once a week, and washes another neighbor’s car twice a month.
Does that seem reasonable? Well, I think so.
What’s a reasonable amount to pay then?
Maybe $50 for a night of babysitting. (x1)
Maybe $20 to walk the dogs. (x4)
Maybe $50 to wash the car. (x2)
So for the month of February 2017, her spreadsheet would look something this:
| Work Type | Location | Employer | Pay | Schedule | Date |
| Babysitting | Neighbor’s Address | Neighbor #1’s Name | $50 | Monthly | 2/11 |
| Walks Dogs | Other Neighbor’s Address | Neighbor #2’s Name | $20 | Weekly | 2/4, 2/11, 2/18, 2/25 |
| Washes Car | Another Neighbor’s Address | Neighbor #3’s Name | $50 | Bi-Monthly | 2/12, 2/26 |
Total = $80 + $40 + $100 = ~ $180 a month
$180 x 12 months = ~ $2160 a year
Dude… Sensei, that’s not much.
You’re right… but wait… $5500 wasn’t much either for the Backdoor Roth IRA… remember? And… well, it’s not that much work either is it. It’s a reasonable amount.
Let’s say my daughter does this from the age of 12 until 18 when she leaves for college. So 6 years.
Compound Interest Calculator: $1, $180/month, 6 years, 6% = $15,068.11
Not Bad Right? What’s better is they can’t touch it until they retire (without significant penalties)… so it compounds until she’s like 65 or so… which is:
47 years
So once again, with the Compound Interest Calculator, $15068.11, $0/month, 47 years, 6% and it’s:
$233,042.13 — go ahead and check yourself. I’ll wait.
Yup. $233k
This also assumes she doesn’t put any more money into a Roth IRA… and I would hope she does during college, graduate school, and then (hopefully) a Backdoor Roth IRA after that every year until she retires.
My daughter was paid $2160/year for 6 years which is $12,960… and it’s worth $233,42.13 when she retires.
And it’s post-tax… and therefore tax-free in retirement.
WHAT THE?
That’s… that’s AMAZING. Yes, I agree.
Wait, can I just pay my children for doing household chores?
Unfortunately, there is some conflicting information about this online. Some sources say that yes you can as long as it’s well documented and “reasonable” while others say “normal household chores” do not count.
What are “normal household chores?” Well, vacuuming the house and doing the dishes probably don’t count. It is legal to hire your own child to do specific work, however, it should fall outside of the realm of normal household chores (which most interpret as weekly).
For example, let’s say I’m going to repaint my own house, which is a big job, so I hire my daughter to help me paint it. This is not a normal “household chore”, but something that happens once in awhile. I would normally hire someone else to paint my house for me, right? So in this particular specific case, I can probably pay my daughter $20/hour for work to paint the house, or whatever the reasonable going rate is.
I would not normally hire someone to vacuum my house or clean my daughter’s room. However, I might pay a maid service once a month, or once every few months to clean my house from top to bottom.
See? It’s kind of a gray area.
Additionally, any income your children receive from you will require additional tax paperwork on your part.
“You’ll have to mess around with some filing requirements (such as Schedule H attached to your personal tax return), complete some additional reports (such as W-2 forms for the kids), and maybe jump through some additional hoops (such as applying for an employer tax ID number using Form SS-4). But, for those of you who want to fund IRAs for your younger children, the hassle might be worth the benefits.” (emphasis mine) Source: Fool.com
Hmm.. well… what do you think?
I think that in order to pay your children for work it must be outside the realm of normal weekly chores. For example, washing the cars once a month probably should count. Mowing the lawn once a month probably should count. Weeding the garden once a month probably should count. Essentially, larger chores that require significant effort and are done once a month or more than once a month are probably ok.
Just remember the pay they receive needs to be reasonable and what I would call “market value”.
For example, if I take my car over to the car wash and get it washed and detailed, it probably costs me at least $75-100. So that’s probably a reasonable estimate.
Basically, what would you pay someone else to do these jobs for you?
Talk with your CPA or tax professional first about what their interpretation is.
You don’t want to go through all of this and document everything and then your tax professional won’t help you fill out the necessary paperwork come tax time.
Interesting… very interesting… but what about “the dream scenario”?
I would be remiss if I didn’t include “the dream scenario” right?
So let’s say some my daughter is a real go-getter and as soon as she turns 12, she starts maxing her Roth IRA doing odd jobs around the neighborhood. Maybe she was an entrepreneur and started a dog walking business where she would walk 6 dogs every Saturday or 3 dogs every Saturday and 3 dogs every Sunday or something.
So now we’re looking at $5500 a year (just like a Backdoor Roth IRA). She saves $5500 a year for 6 years.
Compound Interest Calculator: $1, $458.33/month, 6 years, 6% = $38,365.39
Then compound it for 47 years, without adding anymore to it and you get…
$593,355.93 — Almost $600k
My daughter earned $5500 a year for 6 years for a total of $33,000.
$33,000 before she turns 18 is $600k in retirement. That’s the power of compound interest.
Anything else I should know?
Yes, remember, an allowance is not considered part of this. For example, if my daughter made the $5500 a year doing odd jobs for the neighbors, I can “daddy match” it and give her $5500 of my own money to use and then put away the $5500 she earned.
Or, let’s say she had an actual summer job where she made like $5500. I could once again simply match whatever pay she earned and put it into her Roth IRA for her.
The IRS doesn’t care who makes the contribution as long as it does not exceed your child’s earned income for the year. Essentially, you’re already distributing your own post-tax dollars, so the IRS doesn’t care as long as the child earned the income.
Be aware that if you do plan to do a Roth IRA for your Kids, that will likely need to file their own taxes, even though they most likely won’t need to pay any taxes.
TL;DR
Roth IRA for Kids is a great way to give your children a headstart on their retirement.
However, make sure you are keeping accurate records and your children are being paid reasonably.
47 years of Compound Interest is nothing to scoff at. $13k is $233k and $33k is $600k.
****There is conflicting information about whether household chores count or not. See above.
I’m going to talk to my CPA about this more. However, the “safer” route is that paying for normal weekly household chores is not allowed.
Talk to your CPA or tax professional beforehand to see what their interpretation is.
-Sensei
What do you think? Did you know about Roth IRA for Kids?
Do you plan to make use of one? What job(s) do you think are the best to get to the $5500 cap?
Questions, Comments and Suggestions are welcome.
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My cousin has a business that she runs via a Web site. She has my kids on the site as models. I think it’s fair to have them paid $5500 each year to continually use their photos on her business site. They are each paid with a personal check. Would my cousin need to file any employment paperwork or would my kids just need to file a 1099 with the government? (This may be a better question for an accountant.)
That’s a good job for them. However, I think you need to be careful with your documentation.
Like I said in my post, you need to keep good records. I think that having them receive a lump sum of $5500 would raise some red flags come tax time. It’s more reasonable that they were paid on a per picture basis and/or maybe some retainer thereafter bi-weekly for the continued right to use their pictures on her website. Ideally, your cousin would provide W2s to each of your kids.
From my understanding, for odd jobs around the neighborhood, a W2 is not required. However, if it’s true employment through a business entity, as in this case, I think it is in your best interest to get W2s.
Like I said, I would run all this by your accountant first to see what they are comfortable signing off on when it comes tax time. Otherwise, none of this matters.
There is a lot of gray area to Kids Roth IRAs, so I tend to err on the side of being conservative.
-Sensei
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