Roth IRAs: A smart tax idea for children

Persuading your working children to make retirement contributions may not be easy, but investments in Roth IRAs may be the wisest possible use of their earnings. The nature of Roth IRAs, coupled with the effects of long-term compounding, can create exceptional returns on such early investments.

Although contributions to Roth IRAs are not deductible, earnings within the accounts (such as interest or dividends) are not taxed and qualified withdrawals are completely tax-free. Tax-free compounding can result in sizable accumulation in a Roth. For example, if a 15-year-old contributes $2,500 for each of four years, and the account earns 5% annually, the fund will be worth about $85,000 when the child reaches age sixty.

It’s generally best to leave IRA funds untouched until retirement, but if necessary, your child’s contributions to a Roth IRA (excluding the earnings) can be withdrawn at any time without triggering taxes or penalties. This flexibility provides an advantage over a traditional IRA, where most withdrawals before the owner reaches age 59½ will be taxed and penalized.

The owner’s ability to deduct contributions is the one advantage a traditional IRA offers over a Roth IRA. However, this feature is relatively insignificant for most young earners. The first $6,300 of a child’s 2015 income will be entirely sheltered by the standard deduction, and any earnings above $6,300 are likely to be taxed at very low rates.

This year, most working people can contribute up to the lesser of their earned income or $5,500 to a Roth IRA. Although Roth eligibility is phased out for individuals with income above certain ceilings (e.g., $116,000 to $131,000 for a single person in 2015), a working child’s revenue rarely will approach such thresholds.

If you’d like to learn more about the benefits of setting up Roth IRAs for your children, contact us for assistance.

About Brenda J. McGivern, CPA

Brenda McGivern started her own certified public accounting and management consulting firm in October 2001. The full service CPA firm provides tax and accounting solutions to meet the needs of today's small business and individual. Brenda McGivern has become a trusted advisor and valuable resource her clients rely on for timely, accurate assistance when they need it. Before starting the firm, she worked as an accountant for three years at a local firm and prior to that five years at a large international CPA firm in Boston. She has performed the following tax services: federal, state and local tax planning, international tax planning, estate and succession planning, mergers and acquisitions, capital retention and IRS representation. She has also coordinated assurance engagements, such as financial statement audits, reviews and compilations from the planning phase through the reporting phase. She has prepared and reviewed regulatory filings for numerous regulatory agencies including the Security and Exchange Commission. Prior to these positions she was selected from over 2,000 candidates into an eight-person intensive financial management program at an international technology company. The program consisted of graduate level classroom study and two six-month rotational assignments in financial operations. She graduated cum laude from the University of Massachusetts at Amherst and holds a Bachelors Degree in Business Administration with a concentration in accounting. McGivern also holds a license in Massachusetts as a Certified Public Accountant and is a member of the American Society of Certified Public Accountants and the Massachusetts Society of Certified Public Accountants. She resides in Stoughton, Massachusetts with her husband Brian, and their sons Sean, Ryan and Conor and their dog, Davis.
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