Hiring Your Children Part II: Saving for Their Future
In last week’s article, we covered the basics of hiring your children in your business. Now the question becomes, what to do with their earnings?
Of course, they can spend their earnings on Roblox, Fortnite, clothes, and whatever else kids spend money on these days. But what about using their earnings to save for their future?
That’s what we’ll discuss today!
Leave it in a Savings Account or CD
Remember, the child must actually receive the money you pay them in their bank account. So one option is to just leave it with the bank in a savings account or CD.
However, with interest rates so low that may not be the best option…
Contribute to a Roth IRA
Because your child has earned income, in the form of salary or wages, they are now eligible to open a Roth IRA account.
Roth IRAs are great savings vehicles because the money will go into the account tax-free as children will often not pay tax on their earned income if they’re paid under the standard deduction as we discussed last week. Then, once the money is in their account, it can be invested and can grow tax-free.
From there, there are a number of ways the Roth IRA can be used for their future.
The contributions to the account can be withdrawn tax and penalty-free for any reason at any time. Thus, the contributions can be used to help fund a business opportunity or used to travel once they mature (of course the earnings can too, but just not tax and penalty-free).
They can also use up to $10,000 of earnings from the account tax and penalty-free towards the purchase of their first home.
Another way to use the account is for qualified education expenses if they go to college. Such expenses are exempt from the 10% early withdrawal penalty, however, they will have to pay income tax on the portion withdrawn from earnings.
The final use case I’ll mention is using the Roth IRA to get a head start on their retirement savings (revolutionary, I know). We all know the power of compound interest and getting such a head start can really make a big difference in the long run.
Example
If you contributed $6,000/year for 11 years (by paying your child from age 7 to 18) to a Roth IRA and were able to earn an 8% return, the account would have a total balance of $99,873.
That would be a total of $66,000 in contributions and $33,873 in earnings… Not a bad start for an 18-year-old.
Assuming they continued to invest $6,000/year at an 8% return until the age of 65, they’d have a total account balance of $6,435,871 on contributions of only $348,000!
And by the way, this was not indexed for inflation. The IRS will increase the $6,000 limit over time, but you get the point.
Contribute to a 529 Plan
529 Plans are investment accounts that allow both contributions and earnings to be withdrawn tax and penalty-free when used for qualified education expenses.
Currently, qualified education expenses for college students include tuition and fees, books and supplies, computers, internet access, room and board, and up to $10,000 in student loans.
The account can also be used to pay for up to $10,000/year in tuition and fees for Kindergarten through 12th Grade.
Unlike a Roth IRA or savings account, the downside of a 529 plan is there is no other use case other than paying for qualified education expenses – non-qualified distributions are subject to income tax and a 10% penalty. Thus if your child doesn’t attend private school or college, a 529 plan won’t be very beneficial for them.
The Bottom Line
Paying your children to work in your business is a tax-smart way of shifting income while at the same time teaching them the value of hard work.
You can take it a step further and teach them the benefits of investing for their future by contributing to a Roth IRA or 529 plan. Not to mention help pay for some of the future expenses they may face as adults.
Disclaimer: This is not to be taken as financial or investment advice, please consult your financial advisor prior to making any investment decisions.
