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The Kiddie Roth

The what? I have a confession – I made it up. Actually, “Kiddie Roth” turns up a few Google hits, so maybe I wasn’t even first. But let me get to the point, why a Kiddie Roth? And why now?

I’ll answer the second question first. Jane 2.0 (my 11 year old) had taken the initiative to send out letters of introduction in June to a few local families. She described her prior experience taking care of younger children, and told of her interest in positions available for babysitting/mother’s help. I sure admired her initiative and was glad when she heard back from some moms. This got me thinking, of course. J2 now has earned income.

If you are a regular reader, you’re aware that I have mixed feelings about the Roth IRA. More so for the mistake I believe is made when making large conversions from the traditional IRA. At least the damage is minimal on an annual deposit, if in hindsight, the traditional would have been better, we’re talking a few hundred dollars in extra taxes, not tens or hundreds of thousands. On the other hand, there are times the Roth is a great idea, and this is one of those times.

A dependent minor still gets her own standard deduction for earned income, $5,700 for 2009 & 2010. Since we are talking about only $1500 or so earned this summer, there’s no point in looking at a traditional IRA, but a Roth is ideal. This money will grow tax free until she taps it for retirement. At 8%, over 50 years this money can grow to $70K, at 10%, $176K. I recall an example of early savings from years ago, comparing a 21 year old who makes 5 years of deposits and stops. Someone else starts making the same size deposits at 26, and never catches up. In other words, you can have twice the lifetime return by starting 5 years early. This made me thing how much better a head start I can give my daughter by starting her Roth now.

When I began to discuss this topic, two points came up. No, J2 isn’t going to put this money into the Roth. I plan to give her money that she got got when she was younger and put aside for her. So long as she has earned income, the individual dollars don’t need to be traced to the Roth. Not all brokers allow IRAs for minors. I use Schwab, and they offer an account specifically designated as a Custodial IRA.

When I read articles such as How Much Do You Need To Retire? The 10% Rule, I’m reminded it’s never too early to get started.

What do you think? Is a Roth in your child’s future?

  • Evan August 5, 2010, 1:09 pm

    I am with you on the mixed feelings. I don’t think they are bad, but I think they may be on too large of a pedestal.

    As far as the kiddie Roth, I think it is GREAT! You can fund her retirement with nearly nothing today, and that is some gift!

  • Enoughwealth August 5, 2010, 8:52 pm

    I had the similar thoughts about children’s retirement savings here in Australia when my oldest son started earning income (first from a paper round, later from busking). It was hard to find retail superannuation funds that would setup an account for a minor, but it can be done.

    The situation with superannuation contributions in Australia is a bit different — DS1 doesn’t have to pay any income tax on his earned income below the standard $6,000 threshold (however, any unearned income eg. interest on money received as gifts, is another matter – any amount above $416 gets taxed at a whopping 46%!) but undeducted contributions into a superannuation account are taxed at a flat15%.

    Why would he bother putting money into superannuation if he ends up paying 15% tax instead of nil? Well, at the moment there’s a matching government ‘co-contribution’ of up to $1000 available for ‘low income’ individuals who make an undeducted contribution into superannuation. So if DS1 puts $1,000 of his income into his superannuationa account, he ends up with $850 (after tax) plus an additional $1000 (untaxed government co-contribution) in his super account.

    Ongoing having savings sitting in the superannuation account is worthwhile as earnings are only tax at 15% (regardless of his personal income marginal tax rate) during the ‘accumulation phase’ (up to 65), there is no tax on earnings during the ‘pension phase’ and no tax of withdrawals (after you reach pension age – the biggest restriction is that once money goes into superannuation it can’t be withdrawn except in very limited circumstances).

    Since DS1 doesn’t want to spend any of his income, he’s quite happy to have it all rolled over into superannution. The restrictions on getting money back out of superannuation may also be a plus once he gets to 18 — if his savings were all sitting in a term deposit or stocks, he might be tempted to blow the entire amount on a fast car or expensive girlfriend 😉

  • JOE August 5, 2010, 9:07 pm

    Thank you for sharing this. One thing I am really lacking in knowledge is regarding the tax and retirement saving structures in other countries. The US system is complex enough that one can make a career of simply keeping up with the changes in our own system.

  • Rehan August 6, 2010, 11:59 am

    Can I ask how much documentation you need for her income? Is it enough to get receipts from the people that she’s babysitting for, for instance?

  • JOE August 6, 2010, 12:41 pm

    It’s usually the opposite, no? So long as you are claiming income, you usually don’t worry about ‘proving’ it.
    In this case, when a minor is raking leaves, baby sitting, or other work for neighbors, they are not likely to offer her a 1099. In most cases, they are not even paying by check, which you could just photocopy to keep records.
    On the slim chance her return is audited, I’d suggest a calendar showing her hours worked, and if multiple clients were involved, for whom.
    Keep in mind, the IRS has serious money they are chasing, disallowing my 11 year old’s Roth will net them nothing.

  • Tom @ Canadian Finance Blog August 7, 2010, 10:42 pm

    Thanks for the mention Joe!

  • Car Negotiation Coach August 8, 2010, 11:50 am

    Hey Joe, I’ve actually heard a lot recently about another use of a roth for children. Not opening the account in the kids name,but using your own as a means to save for college. If you contribute college money to your own roth instead of a 529, you can withdraw for your kids college, but it won’t count against you for financial aid. Of course you can only take out principal penalty free, but if it’s lumped in with your retirements savings you still get the benefit of tax free growth. It just takes a little more discipline to make sure 20 years from now you pull out what you want for your kid.

    Any thoughts on that strategy?

  • JOE August 8, 2010, 2:27 pm

    The strategy you suggest is good for those who aren’t counting on using that Roth for their own retirement. You make a good point that the withdrawal does not turn up as income for aid purposes. As a country of people saving too little for their own retirement, it would be a shame to use one’s Roth for their kid’s college, unless they’ve already saved enough.

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