How to smartly invest in your child’s retirement now!
A financial “hack” going around social media states that if you put money into a custodial ROTH IRA account when your child is young and pay them for work they do for your company, they could easily have a million dollars by the time they retire. A tax-advantaged individual retirement account allows individuals to save for retirement while growing money tax-free, after initially being taxed at the time of the investment. But it seems most social media personalities oversimplify the process, says money manager and Buckhead-based Emilie Dayan Hill a chartered financial analyst, and founder of Finance that Feels, a newsletter and educational resource aimed at women. She says it is true that you can set your child up for financial success in retirement through savvy money management of any earned income now. However, this strategy comes with lots of caveats, rules and restrictions. “You should always run this by a tax professional, and this is not personalized advice,” Hill says. Read on to find out if this financial strategy is available to your family and how it might benefit your child.
How can parents use this strategy to help their children save for retirement during childhood?
You can set up a custodial ROTH IRA for a child at any age, and it can grow tax-free. The contribution limit in 2024 was $7,000 a year. If your child’s account is funded the full amount every year from when they were 1 until 18 years old, it could be north of $5 million.
A child has to be earning income in a family business in order for this to work, correct?
Yes, there has to be legitimate work for a legitimate company, such as an LLC or S-Corp. The work needs to be age-appropriate and relevant to the business, whether family-owned or another company. (Be sure to check your state’s labor laws on minimum age to work.) You can’t make up jobs like chores and count that as a business expense. Additionally, your child has to earn more than $7,000. They can’t earn $1,000, and you put $7,000 into a custodial ROTH. You need to document everything and have a paper trail for reporting. Treat your child as an employee for reporting purposes. Issue them a W-2 like any other employee.
You will need to also pay them the market rate. To help visualize this: If you are paying them minimum wage in the state of Georgia ($7.25) and trying to make it to the full contribution amount of $7,000, they’d need to be working 19 hours a week, which isn’t legal for certain age groups.
However, children don’t need to work for a family business to get a custodial ROTH IRA. Your child is eligible to contribute to a ROTH for any job as long as there is a paper trail. For example, if your child gets a job at 15, they could put it into their own ROTH IRA account, but it’s hard to get teenagers to part with their money.
Are there any drawbacks to this retirement strategy?
Your child can’t touch the interest and profit money until retirement age, but they can take out the initial contributions. But the idea is your child could have millions of dollars because the investments have compounded the original contributions.
Are there other ways parents can make money work smarter for their kids?
You could prioritize being able to pay for college by putting money into a 529, which is an education- specific and tax-free account that can only be used for education expenses. You have to pay a penalty to use 529 funds for anything like a down payment on a house. There’s also a plain custodial brokerage account that, like a custodial ROTH IRA, can convert into their name when they turn 18 or 21, depending on the state. A custodial brokerage can be used to pay for anything, but there are no tax benefits.
EMILIE DAYAN HILL
emiliedayanhill.com
@emiliedayanhill
