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The Fiduciary Parent – The Ultimate Plan Sponsor Shouldn’t Overlook this Familiar Tool

The Fiduciary Parent – The Ultimate Plan Sponsor Shouldn’t Overlook this Familiar Tool
March 05
00:44 2019

Plan sponsors act as the parental overseer for corporate retirement plans. They set up the plan. Then determine the grid of investment options. They help the employees direct their earnings into the plan. The employees may have a say in what investments they choose, but only within the confines of the menu already approved by the plan sponsor. In this way, plan sponsors are like parents watching over their employees’ retirement savings.

What if we shifted this simile to a metaphor? And if we’re going to use it as a metaphor, why not treat it as an actual thing?

Parents are in a real position to become “plan sponsors” for their children’s retirement plans. When you think about it, in acting as a fiduciary in this way for their children, they become the ultimate plan sponsor. There’s a tool right at their fingertips they might be overlooking. “When you think of IRAs, you likely picture working adults with retirement on the mind,” says Madison Parker of Parker Financial Group in Overland Park, Kansas. “However, there is no minimum age requirement to open and fund an IRA.”

A Child IRA represents an underutilized tool for parents. “A Child IRA is any retirement account opened for a minor child under 18,” says Keith Poniewaz a Financial Advisor and Director of International Advisory Services at Walkner Condon in Madison, Wisconsin. This is when mom and dad should put on their fiduciary hat. When it comes to acting in the best interests of their children, the Child IRA is a vehicle that’s tough to beat. Consider this. Making the maximum contribution for only four years alone – from age 12 through age 16 – yields $2.25 million when the child retires at age 70 (assuming an 8% annual return). And that’s before you include any future contributions to other retirement plans.

Steven Jon Kaplan, CEO at True Contrarian Investments LLC in the greater New York City area, says, “There are many advantages of setting up IRAs for a child, or for anyone who is young. One major advantage is that money which is invested early and which grows tax-free will end up being worth much more than money which is invested later. Someone who begins investing at the age of 5 and stops investing a fixed annual amount at the age of 15 will end up with more money than someone who begins at age 25 and invests the same annual amount through age 65, even though it is only ten years instead of forty years. This is because of how money compounds through time.”

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While their children may not understand the concept of compound interest or the importance of saving for retirement, the parents do. They’ll see the opportunity of establishing a Child IRA. Even better, they already know how to do it. “So, a ‘Child’ IRA essentially works just like a ‘Grownup’ IRA,” says Parker.

As much as they are alike, there is, however, an important difference between, as Parker calls it, a “Grownup” IRA and a Child IRA. “They generally work the same as ‘regular’/ ‘adult’ IRAs but they require a custodian or guardian (typically a parent),” says Mindy Hirt, Senior Vice President at Argent Trust Company in Nashville, Tennessee.

Financial providers call the Child IRA by different names. Some call them “Minor” IRAs. Others call them “Custodial” IRAs. Whatever the name, a Child IRA requires an adult to oversee the account, much like UGMA (Uniform Gifts to Minors Act) or UTMA (Uniform Transfer to Minors Act) accounts do. “The adult maintains control of the account which must be invested for the benefit of the minor until the minor reaches the required age,” says Adam Dechtman, CFP, Financial Advisor at Dechtman Wealth Management in Englewood, Colorado. “There’s ZERO age restrictions, so if the child has earned income, start an account as early as you can!”

Alas, there’s the obstacle that’s preventing many parents from establishing Child IRAs for their children. “There is a stipulation that might prevent a child from doing so,” says Parker. “you must have earned income.”

Just like other IRAs, contributions are determined by earnings. “It’s always good to save for retirement, but it’s important to note that the child has to have earned income to contribute to an IRA,” says Len Hayduchok, Dedicated Financial Services in Hamilton, New Jersey. “The maximum contribution allowed is the lower of the amount of earned income or the maximum IRA contribution limit ($6,000 for an individual less than 50).”

This means that contribution limits still apply. “The key to remember is that the child must have earned income and cannot contribute more than the amount earned,” says Luis Rosa, Founder/Financial Planner, Build a Better Financial Future, LLC, Henderson, Nevada. “For example, if a child makes $2,500 babysitting during the summer, he/she cannot contribute the max to the IRA.”

“The most important thing about establishing an IRA for a child is to make sure the child has earned income,” says Adam Bergman of the IRA Financial Group, LLC in Miami Beach, Florida. “In order to pay a child income for the performance of services, the services must actually be performed in the context of a bona fide business relationship and the compensation must be reasonable. In other words, if you are not self-employed or do not have a business, you will likely not be able to pay your children for services performed, such as chores around the house. That doesn’t mean that your children will not be able to contribute to an IRA, it just means that the income they earn must come from either business activities they perform or services performed from another business.”

Babysitting is just one example of an income source for minor children. There are any number of jobs teenagers typical have. All these come with wages that can be contributed to a Child IRA. “As long as a child (under the age of 18) has earned income they can contribute to a Child IRA,” says Ben Soccodato, Financial Services Executive and Investment Advisor Representative at The SKG Team at Barnum Financial Group in Elmsford, New York. “Whether it is weekend time spent at the family business, counseling at camp, or a paid summer internship, a child has the right to contribute to an IRA to offset any earned income. Since a child isn’t likely to pay much in the way of taxes (or save as much in the way of tax deferral) – the child may want to consider a Roth IRA.”

Children may not know there’s a pre-tax or after-tax option for IRAs. Their parents, on the other hand, understand the difference. They know what kind of impact the choice will have. “Child IRAs can be set up as a tax-deductible or a Roth IRA, but the Roth is almost always better,” says David Blain, CEO and Senior Wealth Advisor for BlueSky Wealth Advisors, in New Bern, North Carolina. “Why? Because after 5 years, the then adult can withdraw contributions tax-free, even under the age of 59½ – the age you can withdraw IRA money penalty free.”

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Many experienced professionals would recommend parents choose the Roth for their offspring’s Child IRA. “If a child were to contribute to an individual retirement account,” says Hayduchok, “I would recommend a Roth unless the child is earning substantial income (resulting most likely from the entertainment industry) because the child is in a relatively low tax bracket. There is very little benefit to deferring the taxable income. I would recommend contributing after-tax money to a Roth and reaping tax-free growth at a later date. Also, a Roth IRA can be used for education expenses without a penalty being incurred for ages less than 59½.”

“Generally, because they have longer time horizons until retirement and are in lower tax brackets, a Roth IRA is the best choice for most children,” says Poniewaz.

Marianela Collado, CEO at Tobias Financial Advisors in Plantation, Florida, also prefers Roth IRSs for children. “The account grows tax free and when you have very little income, you are not really looking for an income tax deduction,” she says.

Here’s another way parents can proactively help their children benefit from a Child IRA, although this can raise other issues. “In many cases, the parents would usually ‘match’ the child’s wages in the form of a Roth IRA contribution,” says Collado. “Be careful parents, because this Roth IRA contribution does count towards the maximum annual exclusion of $15K per year. So if they are making other gifts to children’s trust (including life insurance trusts), this would reduce the amount you can give to those other wealth transfer vehicles.”

When it comes to the definitive fiduciary, no one can play that role better than the parent. Parents constantly look out for their children. They want to give their children the best possible advantage to live a better life. Sure, this can mean placing their children in advanced educational programs, travel sports, and the best summer camps. Why not give them the ultimate head-start – the Child IRA – and start them on the way to retiring a multi-millionaire!

Christopher Carosa is a keynote speaker, journalist, and the author of  401(k) Fiduciary SolutionsHey! What’s My Number? How to Improve the Odds You Will Retire in Comfort, From Cradle to Retirement: The Child IRA, and several other books on innovative retirement solutions, practical business tips, and the history of the wonderful Western New York region. Follow him on TwitterFacebook, and LinkedIn.

Mr. Carosa is available for keynote speaking engagements, especially in venues located in the Northeast, MidAtantic and Midwestern regions of the United States and in the Toronto region of Canada.

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Christopher Carosa, CTFA

Christopher Carosa, CTFA

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