ROTH IRA’S: The Perfect Savings Vehicle for Small Business Owners Children?
An Advantageous Savings Vehicle for the Children of Small Business Owners
Through the use of strategic planning, small business owners are often able to not only make more money than they would as employees of another’s business, but also avoid paying quite as much in taxes. However, many small business owners struggle not only to save for their future, but also that of their children, without negative tax implications. The benefits of a Roth IRA (commonly called a ‘Roth’) for childhood savings may prove a useful to meet this goal.
What is required for a child to put money into a ROTH IRA?
In order to qualify to place funds into a Roth account, one must meet a few criteria. First, the individual must earn income. Second, that income must be below the qualifying threshold, which changes periodically. Notice, that those requirements do not include a minimum age in order to place funds into such an account. While most children are precluded from saving in a Roth account because they do not have any earned income, a business owner may legitimately employ their children and compensate them in this fashion.
The Internal Revenue Service itself notes that one of the major benefits of owning a small business is the ability to employ family members, even those that might not otherwise have been employed by others. As long as the child performs some work for the business, he or she then qualifies to place that earned income into a Roth product. How to employ one’s child in his business may involve some creativity. Some options include modeling for advertising and promotional material (especially helpful for younger children) and cleaning services.
|ROTH IRA||Traditional IRA||Traditional Savings/Investment Account||529 College Savings Plan|
|Contribution Limits||A maximum of your earned income up to $6000.00 in tax year 2020.||A maximum of $6000.00 may be contributed to your traditional IRA in tax year 2020.||No contribution limits, however contribution amounts made with unearned income on behalf of the parent for the child may result in gift tax implication if over the exclusion amount.||An annual contribution limit of based on state law is allowed towards a 529 college savings plan.|
|Tax Advantages||Contributions made with after tax dollars and all qualified distributions are made tax free.||Contributions made with Pre-Tax dollars allows higher initial investment amount and the reduction of immediate tax burden.||Contributions are made with after tax dollars an d all growth is taxed. All dividend and recognized capital gains must have tax paid in the year in which the income was created.||Earnings from 529 plans are not subject to federal tax and generally not subject to state tax when used for qualified education expenses such as tuition, fees, books, as well as room and board. The contributions made to the 529 plan, however, are not deductible.|
|Permitted Uses of the Funds||Principle contributions may be withdrawn tax free at any time. Up to $10,000.00 for the purchase of a first-time home may be withdrawn after 5 years. All funds may be withdrawn tax free for any purpose upon reaching the age of 59.5.||Funds withdrawn prior to the age of 59.5 are subject to tax and penalties. Distributions made after such time are subject to income tax on the full amount of the withdrawal but not penalties.||Any use is permitted with the funds and funds may be withdrawn at any time.||Funds may be used for educational purposes only at qualifying institutions of higher education. Funds which are not used for educational purposes during the child’s educational tenure may be rolled over to an additional beneficiary. Funds not used for educational purposes are subject to penalties upon withdrawal.|
Why use a ROTH IRA Product?
In a traditional IRA (Individual Retirement Account) pre-tax money is place into a tax-deferred account and as long as no premature distributions are made, those savings grow tax free until retirement. Upon distribution during retirement taxes are paid on the entire amount withdrawn from the account, including the pre-tax principal. Conversely, a Roth is funded using after-tax dollars and does not have any tax implications when the funds are withdrawn during retirement.
When funds are placed into a Roth for a minor child, there will of necessity be many years for that tax-free growth to occur. Thanks to the wonders of compounding growth, the longer the money is invested, the more growth one receives. Further, most children do not run the risk of disqualification for earning above the maximum threshold as they typically earn in a relatively low tax bracket.
Another significant advantage of using a Roth product is the flexibility it presents when withdrawing principal from the account for the child’s benefit. Because the principle contributions placed into a Roth account are post-tax dollars, the principal may be withdrawn from the account while allowing accrued growth during that time period to continue tax free. Plus, for a first-time home purchase, up to $10,000.00 is allowed to be made as a distribution. This makes the Roth IRA the perfect hybrid college savings, home purchase, retirement account for the children of small business owners.
How to set up a Roth IRA for a child.
Setting up a Roth IRA for a minor child is similar to setting up any other retirement account with only a few special considerations. Like other retirement accounts, there are a multitude of providers to choose from, and choosing a trustworthy provider is crucial. Further, when setting up an account for a minor it is important to do so in a custodial capacity so the parent may maintain control of the investments during the child’s minority. It is important to note that when the child reaches adulthood he or she will be entitled to access and control of the account immediately.
The parent will then provide biographic information about both the parent and child, as well as designate each contribution made to the account based on the tax year to which the contribution should be applied. Once funded, the parent will have to choose from various investment options. While the parent will have the authority to control those funds, all the money placed in the account is legally the property of the minor child. This means misuse or appropriation of the funds could be viewed as theft of the child’s property; thus, it is important to always make sure those funds are used for the benefit of the child.
For small business owners with children, strategic saving can appear daunting. Using Roth IRA’s to save for a child’s future is a flexible mechanism with many tax advantages, as well as the flexibility to apply those tax benefits for the child’s education and first home in addition to a substantial jump start on retirement.
If you’re a small business owner, the expert attorneys at The Weil Law Group are here to help with the process of strategically planning to ensure you and your children the greatest advantage, as well as contingencies in the event of the unthinkable. Give us a call at 954-603-7603 and we would be happy to help.
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