Head Start for Ava - Setting up a Roth IRA

It is more of instilling the value in her by handing her the paper record and informing her the username and password, on her college graduation ceremony day(is there better legacy than good values in this mundane world?) Ava, let us live for the PRESENT, and prepare for the FUTURE.

Roth IRAs for Minors

By Kaye A. Thomas
Updated January 26, 2008
http://www.fairmark.com/rothira/minors.htm

Can you set up a Roth IRA for a minor child? Should you?

Traditional IRAs haven't been attractive investment vehicles for minors, in part because young children seldom have enough income to benefit from the deduction. A Roth IRA for a child can be very attractive, however. There's no minimum age to set up a Roth IRA, and many IRA providers will accept accounts for minors. In most cases the only issue is whether the child has taxable compensation income.

Some IRA providers balk at the idea of IRAs for minors, but many mutual funds, brokers and banks accept them, so if you strike out the first time you ask, try again elsewhere.

A beautiful idea

Tax-free compounding of earnings inside an IRA is a beautiful idea — and a powerful one. The longer you can keep your money invested in a tax-free vehicle, the greater your wealth accumulation. What better way to accumulate a large amount of savings than to start during childhood? When tax-free compounding has more than 50 years to run its course, a relatively modest savings plan can produce substantial wealth.

There's no minimum (or maximum) age to set up a Roth IRA. And there's no requirement that the same dollars that were earned be used to fund the IRA. If your child earned money on a summer job and spent it on whatever kids spend money on these days,* there's nothing wrong with using money provided by parents to establish the IRA. The child has to have earned income, though.

* A recent report says the number one category isn't CDs or video games: it's food.

A drawback

Money in your child's IRA belongs to the child. There's no way to restrict the child from withdrawing it and using it in any way he or she chooses, at least after the child reaches the age of majority. Bear this in mind before you pour many thousands of dollars into an IRA for your child.

The earned income requirement

The major impediment to IRAs for children, especially young children, is the earned income requirement. An unmarried person must have earned income of his or her own to contribute to a Roth IRA. The income has to be compensation income, not investment income. And it has to be taxable compensation income. For example, income covered by the foreign earned income exclusion doesn't qualify.

That doesn't mean your child has to actually pay tax on the income. If the total amount of income is small enough so your child doesn't have to pay tax, that's okay. But your child has to have the kind of income that would call for a tax payment if the amount were large enough.

Example: Your child earns $2,350 bagging groceries after school and during the summer. No tax is due on this amount — the only reason to file an income tax return is to get a refund of any withholding. But your child can contribute to an IRA because the earnings are taxable compensation income.

Income from a parent's business

What if the parent is the employer? The fact that the income comes from a parent doesn't disqualify it, although the IRS may take a closer look in cases like this.

There have been a number of court decisions dealing with parents who paid children to work in the parent's business. None of them deal with the Roth IRA, though. These cases generally deal with the parent's deduction for the amount paid to the child. The Tax Court has allowed the deduction when it was convinced that the parents paid fair compensation for work actually performed in a real business. When the compensation wasn't a reasonable payment for work actually performed or didn't relate to a business, the deduction wasn't allowed. Bogus compensation won't support a contribution to a Roth IRA, either.