Who is Using The Child IRA Right Now
(This is the third in a series of three installments.)
Previously, we discussed one way to fund The Child IRA, (see “How to Take Advantage of The Child IRA Under Current Laws,” FiduciaryNews.com, July 13, 2016). The good news, we learned the most obvious way (once you realize it) for children to earn income from virtually the moment they’re born. “Under the age of 5,” says Ira Smilovitz, Enrolled Agent and owner of Glenwood Tax Services in Leonia, New Jersey, “the typical job is as a child actor/model. Earnings can be anything from a few hundred dollars to many thousands.”
The bad news, we also learned this ideal approach requires much advance planning and almost immediate action. For many, we are well past this stage in the child’s life. Rest assured, though, as the first installment of this series told, children well into their elementary school years can still avail themselves to The Child IRA. Beyond infancy, paid prospects begin to broaden. Saul Simon, financial advisor with Lincoln Financial and President of Simon Financial Group in Edison, New Jersey says, depending on the child’s age, employment opportunities can range from “pictures for marketing promotion, filing, cleaning, and sweeping.” Besides using the income to fund The Child IRA, getting a job helps the child by “teaching responsibility and money values,” says Simon.
Once a child celebrates his graduation from kindergarten and into the pre-teen years, we start to see more traditional work become available. Rocky Lalvani, Enrolled Agent and Financial Coach located in the Harrisburg, Pennsylvania Area says regarding the ages between 6 and 12, “at the upper end of this would be babysitting, yard work, and other household chores. They could also help setting up technology. Because of their age the wages will naturally be very low.”
Be warned, however, since paying children for working around the house may garner the attention of regulators. “The children’s ages can vary and their duties and pay will vary accordingly,” says Sean Moore, CFP, President of SMART College Funding in Boca Raton, Florida. “The pay needs to be commensurate with the work performed, and both must be reasonable. Paying your 8 year old $30 per hour to take out the trash not only sets unreasonable expectations about the value of a dollar, it may also raise eyebrows at the IRS. While small children will probably get paid at or near minimum wage, older kids may prove to be far more valuable to the company and paid handsomely.”
Upon reaching the teen years, all those years of technological immersion – yes, that includes video games – can begin to pay off. “Most of the work is now social media driven because young kids know platforms such as Instagram, Facebook, Snapchat better than their parents and for the cost can do a really good job in helping an owner brand their business,” says Ted Jenkin, Co-CEO and Founder at oXYGen Financial in Atlanta, Georgia. “Otherwise, mostly menial day to day labor type tasks. You must pay the kids what would be considered to be fair compensation for that job if you were to hire someone out in the open marketplace – $12 to $18 an hour depending on age and skill. The most important thing is to have the job fully documented and set up an HR file for your child.”
More appropriately, rather than paying for housework, it may make more sense – and have its own set of additional advantages – for parents and grandparents who own their own businesses to hire their family descendants. “I know parents that hire their children,” says Moore. “In fact, I actively recommend that business owner parents hire their children and then use some (or all) of the proceeds to fund an IRA.”
Earning enough money to fund The Child IRA helps the child, but do you know hiring their child can also help the business owner. Edward R. Collins, Founding Partner & Wealth Advisor at Artisan Wealth Management, LLC in Lebanon, New Jersey calls it “a dramatically underutilized tax savings strategy to hire younger family members and put them on the books. Most business owners don’t realize that there is no requirement to withhold the traditional payroll taxes (FUTA, SUTA, FICA, etc.) when paying ones’ own children under the age of 18, so long as the business is a sole proprietorship or a partnership in which each partner is a parent of the child. Even though this benefit goes away if the business is a corporation or includes partners who are not a parent of the child employee, almost every state allows for the child employee to be waived out of Worker’s Compensation coverage if they are covered under the family medical plan of the business owner.”
Besides payroll taxes, there may be income tax benefits. “Depending on the income you actually pay to the young family member, and depending on whether or not they file their own income tax return, there may be no income tax liability regardless of the funding of a retirement plan,” says Collins. “Every person who files an income tax return is eligible for the Personal Exemption and the Standard Deduction. For 2016, the Personal Exemption is $4,050. The Standard Deduction is $6,300 this year. When I am suggesting this strategy I typically focus on children under the age of 18. They often do part-time work – clerical or general administrative. It needs to be at least just enough from a legitimate compensation perspective to meet the IRS earned income requirement. It is extremely important to note that taxes are a complicated animal. Before implementing any strategy, one should consult with a qualified financial professional to ensure they are coloring within the lines with the IRS.”
Once the necessary income is earned, the next task is to determine which form of IRA should be used for The Child IRA. “In nearly all scenarios,” says Moore, “I recommend using a ROTH IRA. Because most children’s income will be less than the standard deduction, the ROTH IRA is a perfect fit. It allows for tax deferred growth, tax free withdrawals of contributions at any time, penalty free withdrawals of earnings for college expenses and tax free withdrawals upon retirement. Some families are just starting to take advantage of this strategy while others have been doing it for 5 years or longer.”
Bob Chitrathorn, Vice President of Wealth Planning/Senior at Trilogy Financial in Corona, California, agrees with Moore. He says parents “are using ROTH IRA’s and have been doing them for a few years.”
Remember, with The Child IRA, the child only needs to earn the money. That money could be spent on other items and the actual contribution can come from any source. “Often the parents will gift the IRA contribution,” says Smilovitz. “In other words, if the child earns $1000, the parent(s) gift $1000 to the child to fund the Roth IRA and let the child keep the earnings to use as s/he wishes (subject to parental approval).”
What follows is a compilation of several real-life examples of The Child IRA in use. Parents and grandparents expecting a new addition to their families might be mindful of these stories, especially if they own a small business.
Benjamin L. Grosz is a benefits and tax attorney at Ivins, Phillips & Barker in Washington, DC, says, “I know a business owner who hires his nieces/nephews (he has no children of his own) and has coordinated with their parents to use the funds to set up Roth IRAs for the children. They have been contributing to them for a number of years. The children were first hired when the youngest was quite young (age two, I think). They have been employed as models, and paid in line with industry norms.”
“I know half a dozen – maybe more – real estate investors who do this,” says Don Tepper, Owner of Solutions 3D, LLC in Fairfax, Virginia. “Most of the children are now age 10 or greater. The type of work they do includes envelope addressing, postcard addressing, stuffing letters into envelopes, applying stamps to envelopes, and sealing them. (Basically, different elements of direct mail campaigns.) The pay range is between $7-$15 per hour. They have been contributing since the child/children were old enough to perform some sort of useful work – in a few cases that I know about, around ages 6 or 7.”
Of course, it’s not surprising that financial advisers themselves have taken advantage of The Child IRA. “I was able to give my kids ‘$200,000’ this past Christmas in their retirement account,” says Lalvani. “I did this, making sure they had earned income and then figuring out the best retirement account to put it in. It’s hard for younger kids to earn an income and if the IRS thinks it’s not reasonable you may run afoul of them. Laws make it hard to work for someone else.”
Smart parents have long known of the concept of The Child IRA. Here’s a testimonial from someone whose father used The Child IRA two decades ago. “My father did this for me when I was 12 or so,” says Erin Kelley, Founder & CEO of Collizio, Inc. in Washington, DC. “I did clerical work (filing, mailing, etc.), and I was paid $7 an hour. I worked enough to maximize the contribution. We used a ROTH IRA. I still have it, 20 years later, though I used some of the contributions to pay for graduate school. ”
Kelley exposes one of the drawbacks of using a ROTH version of an IRA for The Child IRA. Since one can withdraw from a ROTH without consequences after five years, there may be a temptation to use that money to pay for expenses other than retirement. Casey St. Henry, Financial Associate at Thrivent Financial Ellison Bay, Wisconsin says, “I work with a number of small business owners who employ their children and use their earnings to fund a ROTH IRA on the kids’ behalf. They tend to choose the ROTH account for the tax-free withdrawals to help fund their children’s education. The folks I’m familiar with all have children in the 6 – 14 age range, and they do a number of different tasks. One of my colleagues has his five children clean the offices of his business. They go in every Sunday after church and get their work done. Another family that I work with owns a restaurant, and their three kids do everything from salad prep in the kitchen to bussing tables to hosting and working as wait staff during the slow times. I don’t know their actual pay range, but all of them work pretty much year round, and come close to maxing out their ROTH accounts at $5,500 per year. I find that the amount of time that they’ve been using this strategy depends on how early they have been made aware of the possibility and the risks inherent in the workplace. Many of the people I work with have low-danger businesses, so the kids can start young, doing menial tasks, without much risk of injury.”
“The Child IRA” may represent a recent name for something that a few forward thinking people have been employing for some time. It a retirement savings tool that has been far too underutilized. Granted, regulators have not made it easy for children to start their own IRA. For instance, it might be easier if the IRA contribution rules were changed to allow parents, grandparents, or any other adult for that matter to fund Child IRA contributions out of the donor’s earnings rather than require the child to have earnings. Still, that there are a number of Child IRAs currently in existence attests to the usefulness of this idea.
Back to the Beginning: Everything You Always Wanted to Know About The Child IRA
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