I’ve heard this is a good way to set your kid up for success and take advantage of compounding. One of the parts I always get caught up on when looking into it, is that your kid needs some form of taxable income, and whatever they contribute, you can match it.
If you have a child that is just a couple years old, how do you accomplish this? I can’t just say I pay her $3000 a year for picking a book to read each night…or can I?
Your kid would need reported W2 income to be eligible. Start a 529 plan instead.
Agreed that a 529 seems to be the right answer. Be aware that it does have its own rules and limitations (main goal is for it to be used towards education), which I believe can be broken for a percentage fee.
Right. I set up one of these when my child was born, but was looking for other options as well. The 529 will probably reach it’s peak right before college, where as an IRA will (potentially) grow for another 40 years
A law was recently passed allowing up to 35k from a 529 to be rolled into a Roth IRA in the beneficiary’s name, so that could be an option. There are some stipulations but it’s better than it going to waste.
Also, specifically for this 35k lifetime transfer from 529, the IRS has yet to do rulemaking where they decide/declare whether this 35k is subject to the earned income requirement. I doubt they break with tradition and exempt it, but if they did, you could just contribute from your child’s birth the IRS maximum. Even still, if your kid gets odd jobs in the summer as a teen, work study in college, or whenever they get their first job you could transfer up to their total annual earnings from 529 to a Roth for them. Even doing $6500 for a few years in early 20s would be an unbelievable head start since most normal people can’t really get on their feet to start saving until mid-late 20s…or later as they have income but it’s not enough to also let them save.
Sincerely wish they had an income limit on this as it’s just a benefit to the mostly rich.
It doesn’t have to be W-2 income, but that’s a lot easier than other options to justify to the IRS. But as long as the money is coming from someone not directly related to the child for work actually done, you don’t need a W-2.
So if the child does modeling or other contract work, it counts. Birthday money and allowances do not.
I see. So how do most people do this for their kids? Do they report their income and have their children pay taxes?
You have to wait until your kid has earned income, and the max your kid can contribute is there earned income or the IRA max, whichever is lower.
But an IRA isn’t the only way to help your kid save for the future. Here are some other options:
- 529 - no taxes on gains if used for education expenses, and some states offer tax incentives
- UTMA - basically a custodial account with tax advantages; the money will be in their name, so it could impact eligibility for financial aid
- trust fund - a lot more flexibility for the parent on when and how the child can use the funds
- Treasury bonds, like ibonds
I’m sure there are others.
Our plan is a 529 and an informal offer to match my kids’ IRA contributions until the leave the house. We’ll also offer to help in other ways, like a car for school (if needed), a down payment on a house (if wanted), etc. But aside from matching their IRA, we plan to retain control.
All very good advise; Thank you! I’m just trying to prepare so I can give the kiddo the things I never had. I will look into these more.
I hope you find something that works for you.
I think the best advice I’ve heard is the airplane oxygen mask analogy. Make sure you’re set before helping others. You don’t want your kid to have a fully funded education and end up not being able to go because they’re stuck taking care of you. So make sure you have your own retirement and insurance figured out before worrying about your kid’s future.
Yes, very good point. I’ve been following the /r/personalfinance flow chart for a while, and it more or less focuses on your own retirement/ savings first.
I have one of those setup already. Was just trying to do as much as I can
I’m no expert, but I’m gonna say no. Your child would need to have earned income. Allowances or getting paid for household chores isn’t going to cut it.
My state gives me 10% back as tax refund for contributing up to $5000 a year to my kids 529.
I need to look into that for mine. I live in Ca but I have a NY 529 (they have a solid performance history). So I wonder if I’d still qualify for any incentives
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