37 How to kick start your kids wealth
What’s up everybody and welcome to the Financially Free Journey podcast where I aim to dispel the seemingly complex topic of personal finances, money management, debt, savings, investing and even retirement. This podcast is designed to help you feel empowered by increasing your knowledge so you can flex your money muscles!
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The title of this episode is juicy and I know most parents out there listening right now have thought about how they can try and set their children up for financially success. How can we make our children better than us? How can we get them started early and steer them in the right direction?
Well today, we are going to be talking about a very under talked about and utilized option for really kick starting your kids wealth and building up a financially successful future!
So heres the deal. Very little people talk about or even know that minors can have IRA’s or individual retirement accounts. As the parent, there are some simple rules for you to follow and really set yourself up for success.
Think about it, setting your little one up with an IRA could help pay for college and their own retirement in the future.
In this episode I am going to go over the simple IRS rules that you need to know in order to setup an IRA for your kids and then the benefits of doing so and when or how you can spend the money that is in the IRA.
If you have put your kids future as a priority and want to also teach them the fundementals of investing, establishing an IRA for them is a fantastic way to do it. As the parent, you can open and manage the IRA for your children until they become an adult themselves.
Let me lay out an example of just how impactful this money move can be for your kid in the future.
Let’s say you contribute $500 a year or to break it down further, about $40 a month into your kids IRA and you do this for 5 years. Lets also say that your kid never contributes to the IRA as an adult. Let’s also assume the average return for an IRA of 8%…at the retirement age of 65, your child will have close to $100,000, thanks to you.
Can you imagine if your parents gave you this gift? Can you imagine if you could factor in $100,000 from your parents into your retirement plans? I can’t think of a better way you can help set your kid up for financial success as an adult.
Can you spare $40 a month for your kid? Most of you listening, that is the difference of going out to eat 1 time a month. Giving up that takeout 1 time a month could help supercharge your kids financial future. It seems like a no brainer to me.
Now lets take it one step further, let’s say that you took this opportunity to teach your child about saving and investing and instilled in them the importance of saving for their future. Lets say your kid continued to save for their future when they become an adult and continued contributing $500 a year or $40 a month until they turn 65 years old. Your child’s IRA would be worth close to $300,000 by the time they are ready to retire.
Again, I don’t know about you but an additional $100,000-$300,000 at retirement thanks to my parents contributions and money lessons would be an amazing gift, don’t you think?
And as the majority of you may already know, the longer you wait in life to start investing and saving for your retirement, the more you have to personally contribute because you don’t have that 8th wonder of the world, compound interest, working for you all that time.
Putting away small amounts of money for a long period of time can make you a millionaire and this is something you can help your child do for themselves by getting it kick started. Even if you save $125 a month for 50 years, assuming the average 8% return in the market during that time, you or your child will have amassed $1 million dollars.
WE ARE GOING TO TAKE A QUICK SPONSOR BREAK BUT WHEN WE COME BACK, WE WILL GO INTO THE SIMPLE RULES TO START AN IRA FOR YOUR KID SO DON’T GO ANYWHERE!
Welcome back everyone! I hope you enjoyed that quick break from this episodes sponsor.
Many people don’t even realize that minors can have an IRA and you can make contributions to an IRA when you receive taxable income during the year. The only restriction with a traditional IRA is that you cant contribute after the age of 70 ½.
So lets say a child earned money during the tax year, you or your child can contribute as much as the child made during the tax year up to the annual limit which is currently $6,000.
Here is the part you have to really understand, the earned income has to be documented which means you cant just fund an IRA for your child who cant legitimately earn income. Can cant pay your kid for their chores around the house and contribute it to an IRA WITHOUT PROPER DOCUMENTATION. You also have to pay your children reasonable rates for things. For example, how much would you really pay your child to fold the laundry or take out the trash? It has to be a reasonable amount.
So you may be wondering, how then can I contribute to an IRA for my child? Lets quickly go over the allowable types of income for a minor:
There is wages, tips, commissions and self employment income.
So here are the most popular 2 different types of income we are all familiar with as adults and this applies to children as well. There is of course, w-2 income. Your older kids may have a part-time of full-time job depending on the time of the year. The amount that is shown in box 1 on their w-2 is the amount they can contribute into their IRA for that year, up to the annual limit of $6,000.
Now there is kids who don’t have w-2 income but they babysit, mow lawns, do household chores. What about these kids?
Kids or adults who earn income on their own, without an official business structure are sole proprietors. This is the type of business structure that people use when starting a business, it is typically operated under your SSN and it doesn’t require any formal business documentation to form.
A sole Prop is owned and operated by one individual person, the business name is the same as your child’s name or you can choose something different if you want.
For a childs self employment income to count aka their money from baby sitting, mowing lawns, taking out the trash and lemonade stands…for it to be eligible to contribute to an IRA, YOU or your child must file an annual tax return. You will use schedule C or schedule C-EZ to report the income and any related expenses to earning that self employed income.
Now if you want to count what you paid your child in chores, baby sitting, etc…remember that you have to keep a detailed record. Maintain a record showing the date, amount they were paid and for what. To take it one step further, you can open a savings account for your child and write a check to your child for the work they are completing for compensation. This way, at the end of the year, you have a detailed record and can just refer to the bank statements for your taxes.
Just something important to note here, even though your child must have earned the money in order for it to count to the IRS, that specific money isn’t the money that has to be deposited into the IRA. In other words, it doesn’t matter where the contribution comes from, as long as it doesn’t exceed the amount your child had earned throughout the year and you have documented.
Also another note, contributions to an IRA can be made anytime throughout the year and can be made up until April 15th of the following tax year. So if you are wanting to contribute $500 to an IRA for your child for 2020, you can make that contribution up until April 15th, 2021.
Another great tip here is you can setup a “matching program” for your minor. If they earn a specific amount of money and contribute it to their IRA, you will match up to a certain amount. What a cool way to teach your child this very important concept to get them prepared to contribute to a 401k and capture that employer contribution.
Now, lets talk about HOW you go about opening an IRA either for yourself or for the purpose of this episode, for your kid.
The formal name of an IRA for a minor is called a custodial IRA and you can open this at any major bank or brokerage firm like fidelity, Charles schwab, TD ameritrade or USAA.
The account will actually be in your childs name but you as the adult, will manage the account until your child turns 18 years old or depending on your state, your child may have to be 21 to take control of the account.
You will probably have the choice of opening a traditional IRA or a roth for your child. Just remember, with a traditional IRA, you don’t have to pay taxes on the contributions when they are made. The taxes are made when your child starts to take withdrawls from the account as an adult.
Now that the IRA is open for your child, you will have to pick what investment vechiles your childs money will be invested in. Remember, your child has a long time for this money to grow so the objective here is long term growth. Talk to the professional helping you open the account about the options that are available to help meet your long term growth objective. This typically is in the form of equity investments like stocks.
Now, there are some amazing benefits that come along with opening a roth IRA for your child like for example, after you have had the account opened for at least 5 years, you can withdraw funds from the account prior to age 59 ½ that were previously taxed without having to pay any penalties or additional taxes.
Usually withdrawing from a roth IRA triggers income taxes and a 10% penalty if you haven’t reached the age of 59 ½. There is one exception to this rule though which is pulling the money out to [pay for qualified educational expenses.
This means with this option, your childs money isn’t ONLY locked up for retirement. Your child has more options with their money and the IRA once they become an adult.
Now, it is always better to not withdraw from the account because the money is compounding and growing but its good to know that there are options for pulling the money out and I would encourage you to talk to a financial professional about this option for your child and see if it does make the most sense for your financial situation.
Thanks again for tuning into todays episode and I hoipe that this episode inspired you to not only focus on your financially free journey but how you can help your child start their own financially free journey and really set them up for success and their financial future.
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Until next time!