Question

I have a successful business and have money to invest.  Can I open an IRA for my child?  Can I put money into an IRA for my child or grandchild?

Answer

As a general rule for 2016, a person may contribute up to the lesser of $5,500 or the taxable earned income.  Investment income does not count.

So the child could work and put up to $5,500 of their income into an IRA.  If the amount contributed is all of their taxable income, their standard deduction will mean they won’t pay any income tax anyway so it would be better to put it in a ROTH IRA instead of a traditional deductible one and let it grow tax-free, not tax deferred.

The good news is that it doesn’t have to be your child’s income that goes into the account.  They just need to have enough earned income to qualify.  For example, if your teenage son works part time and earns more than $5,500 this year it doesn’t matter where that money goes, you can put $5,500 into his IRA for him.  It is treated as a gift from you, but he can take a deduction for it if it goes into a standard IRA.  Again, it is probably better to put it in a ROTH IRA and ignore the potential deduction since it would yield little or no tax benefit now for the child.

As an added bonus, if you operate your business as a sole proprietor and not a corporation or partnership and you employ your under-18-year-old child neither you nor the child is liable for Social Security, Medicare or FUTA taxes.   This means that you can:

  • Hire your child
  • Pay him $5,500
  • You deduct it as an ordinary business cost
  • He puts the $5,500 into a ROTH IRA account
  • According to current tax law. Neither of you will pay Income, SSI nor Medicare tax on that money or it’s earnings – ever.
  • When your child withdraws the money from the ROTH later it is tax-free.

Need to know How Much you Can Put in Your Small Business Retirement Account, read this article.

Or if you’re looking for Oklahoma small business tax savings, you could:

  • Hire your child
  • Pay him $11,800 ( $5,500 + $6,300 standard deduction )
  • You deduct it as an ordinary business cost
  • Your child puts $5,500 into an ordinary (deductible) IRA account
  • According to current tax law, you will never pay Income, SSI or any tax on that money.
  • Your child will pay no tax now but may pay tax on the IRA distributions later.

An Alternative

Put the $5,500 into a ROTH IRA instead of an ordinary IRA and he will pay a small amount of tax now in exchange for tax-free income later, which is probably a better deal.

You will need to document the job he or she performs in case of an audit, which means simply treat their job as you would any other.  Just create a job description for the work the child will perform and use a timekeeping system like you would with any other employee.

Now here’s the fun part.  Imagine you start doing this for your 14-year-old child and they keep up the habit of putting $5,500 into their ROTH account until reaching 59 years of age.  If the account earned an average of 8% return on the investments there would be about $2.3 million dollars in the account which could all be taken out tax-free.

We Are Here To Help

You can see what an amazing gift it would be to teach a child to save and help them save for a secure retirement.  I have used the current IRA limit for my illustration but even if you start with a lower contribution amount the key to success is to start now. Our Oklahoma City CPAs and Tulsa CPAs help your lower your small business taxes. Find out more by contacting our offices in Oklahoma City: 405-720-1244 or Tulsa: 918-477-7650 today. Let our experts help you with any of you bookkeeping, payroll or tax needs.