The best way for children to save for retirement

Worried about getting Social Security as promised? If you’re not, don’t read the next paragraph.

The Social Security Administration recently issued a notice to the public summarizing the report The Trustees of the Social Security and Medicare trust funds. It stated: “The OASI trust fund (Old Age and Survival Insurance) will be able to pay 100 percent of total scheduled benefits through 2033, reported a year earlier than last year. At that point, the fund’s reserves will be depleted and current program revenues will be sufficient to pay 77 percent of the scheduled benefits.”

If you think you have it bad, imagine what it will look like for your children and grandchildren. Will Social Security even be there when they retire?

If you have come to the conclusion that you should not depend on the benevolence of the government for your and your descendants’ retirement, congratulations, you have taken the first important step in protecting your family. Now you can move on to the next step and actually do something about it.

Have you started a 529 plan for your kids? If so, there’s a new way to use it to save for retirement. You can read about it here. If you don’t want to wait for this decade-plus process to work, there’s something you can do now. You can start a children’s IRA for your children. All that is required is that your children have earned an income.

What is considered employment income for a child?

A Child IRA is just like an IRA you would set up for yourself. The only difference is how it is set up. But it still requires the IRA contributor (in this case, the child) to receive earned income during each year of contributions. Believe it or not, this may be easier than it looks.

“Earned income can be a paycheck from a regular job (not many toddlers will have these), or it can be money a child has as self-employed,” says Boston-based Andy Rosen, an investment and tax spokesperson for NerdWallet. “If you can give your child a gig, babysit, walk dogs, or sell items online, they may be eligible to contribute to a ROTH IRA. Please be aware that child labor laws may limit the paid work your child is allowed to do.”

There may be more flexibility if you have a business (whether full-time or a side business).

“A great scenario is where a parent runs a business that is reported on Schedule C of their tax return and their minor child is an employee,” said Robert Steinberg, founder and CEO of Blue Chip Partners in Farmington Hills, Michigan. “The child can receive wages and the parent does not have to withhold Social Security (FICA) or Medicare. Years ago, we had a client who owned their own business and they hired their children to clean the building and do other chores such as data entry. They received wages that were not subject to employment tax and the children were able to open a ROTH IRA because they had wages. This special rule only works for schedule C filers and not for companies.

If I pay my child for chores, is that earned income?

Many parents pay their children a supplement. This can be a “payment” for doing household chores or other activities for the benefit of the family. You may be wondering if this counts as income. Unfortunately not.

“Income from household chores is considered unearned income,” says Alvin Carlos, managing partner at District Capital in Washington, DC.

Similarly, money received as a gift from any source cannot be counted toward the income requirement that determines how much can be contributed to a child IRA.

“You can’t use a gift as earned income for this,” Rosen says. “The money has to come from work. So if you’re thinking about just writing your kid a check and then using it for a ROTH IRA, you’re out of luck.”

What is the Best Retirement Plan for Kids?

Underage children who have started their own businesses often find it helpful to consider setting up SEP-IRAs or so-called “Solo” 401ks. This is most likely an option for enterprising teens. In general, however, the standard IRA represents the best way to create a child IRA.

It then boils down to a choice between using a traditional tax-deferred IRA or an after-tax ROTH IRA. Considering your child’s likely income levels, you will find that the ROTH option offers the greatest benefit.

“If your child earns less than the standard deduction ($12,950), your child will not owe any federal income tax on their earnings,” says C. Ryan Quinty, financial advisor at Cyndeo Wealth Partners in St. Petersburg, Florida. “In very low-income cases like this, it’s best to open a ROTH IRA.”

Even if your children have to pay taxes on their income, the tax deferral benefit today may not be enough to offset the benefits of tax-free withdrawal in retirement.

“Assuming a low tax rate (not a Hollywood star), then a ROTH IRA makes the most sense,” says Steinberg. “The value of the tax deduction for a minor is probably small, but the benefits of tax-free accrual for life are significant.”

At what age can I start a Roth IRA for my child?

How old should your child be before you start thinking about setting up a child IRA? You may be surprised that there is no age limit.

“The youngest age to open an IRA is birth, as long as the child has earned income,” said Andrew Latham, director of content for in Santa Ana, California. “It is of course rare for young children to earn an income unless they are paid for the work they do as a model, actor or artist. The key to qualifying for an IRA is that you earn income, and the income must be earned through some form of labor or service, rather than being gifted or inherited. The child must have earned an income equal to or greater than the contribution amount in order to contribute.”

In all cases, however, you must sign the documents on behalf of your child. Minor children are not allowed to enter into any agreements, so an adult (ie a parent or guardian) must act as their custodian for these accounts.

“To set up a Child IRA, contact your bank or brokerage firm and follow their instructions for opening a custodial IRA,” said Kimberly Bridges, senior vice president and director of financial planning at BOK Financial.
in Dallas. “Not all banks and brokerage firms offer them.”

Financial firms may use different names for these accounts. They could be called “Child IRAs”, “Minor IRAs” or “Custodial IRAs”. They may also simply be referred to as “IRAs”. You must make it clear what you intend to do.

Guiding your kids on the path of starting a Child IRA will be their first step toward financial independence, no matter what happens with Social Security.

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