Last week I explained some of the rules and tax smart tips you need for hiring your children to work with you in your business. As I discussed on page 32 of my book The Doctors Guide to Real Estate Investing for Busy Professionals, you should be hiring your children to work in a business you own, and use the money they earn to fund their Roth IRA. This will turn your children into multi-millionaires and make them set for life. The best part is the government will pay for more than half of the investment. Depending on how you implement this, the government could even foot the entire bill.
Before we look at the tax benefits that make this so powerful, let’s look at what happens when you put money into your kid’s Roth IRA and take advantage of the power of compound interest.
IRA deposits can only come from earned income. As I explained last week, your children will earn income from working in your business, report that income on their tax return, and use that income to make a Roth IRA deposit every year.
If you hire your children to work 10 hours a week for your business and they work 50 weeks a year at the Oregon minimum wage of $12 (Beginning July 1, 2020), they will make $6,000 a year in earned income.
If your children work for you between the ages of 10 and 18, and make only eight years’ worth of Roth IRA contributions, they will have contributed a total of $48,000 to their IRA account. If those contributions were invested in the stock market earning an average of 8% per year, and if this account remained untouched for 50 years after leaving high school, over the entire 58 year period, at age 68, your children will have a balance of $3,630,340 in their IRA account to use for their retirement.
If they were to follow the 4% rule (limiting the annual withdrawal to 4% or less should allow the funds to last for the rest of your lifetime) and begin taking Roth IRA distributions at age 68, they could take out $145,213 a year, tax free, for the rest of their lives. That assumes they never saved any other money in any other retirement account after they graduated from high school. Starting your children’s Roth IRA account early gives them a very nice boost for their retirement years and it all happened in 10 or less hours a week before they left high school.
The icing on the cake is the government will pay for more than half of it. When you hire your child under the age of 18, neither you nor your child will pay social security, Medicare or federal unemployment taxes. These savings add up to 21.3 % of the $6,000 or $1,278. (7.65% would have been the employee payroll deduction and 13.65% would have been paid by the employer.)
If you are paying federal + state income tax of 40%, then their $6,000 salary will be a write off for your business which nets you another $2,400 in tax savings. When adding this to the $1,278 in special tax benefits you get for hiring your child instead of someone else, the government contributes (in the form of tax savings) a grand total of $3,678 to the IRA and your business pays only $2,322 for the work your child completed.
There are a lot of ways you could share this savings with your child.
1: You can have them put all the money they earned into their Roth IRA. This option might not be popular with your kids since they are working but not seeing any immediate tangible reward.
2: You could give them a matching gift. They put the $6,000 they earn into their IRA and you gift them an additional $6,000 to spend or save.
3: You could have them put the $6,000 they earned into their Roth IRA and you give them the $3,678 the government contributed as your tax savings.
4: They could keep the $6,000 they earned and you could contribute the $3,678 this arrangement saved you in taxes into their Roth IRA.
That last one is very cool. The money the government gave you and your child in tax breaks was $3,678 each year. If you only invested that portion into your child’s Roth IRA, and the child kept the salary they earned, then the entire Roth IRA was filled by the government. Under the same investment terms I used above, that account would have a value at age 68 of $1,555,887. Following the 4% rule, your child could then take out $62,235 a year for the rest of their life, tax free. The best part is it was fully funded by the government. Free money. I never like to pass up free money.
Funding your children’s retirement account is a really great additional benefit for having your child work alongside you in your business, while you teach them lessons on money management, work ethic and investing. Be sure to work with your children on what investments their IRA money goes into, and watch the resulting growth.
I only wish I had thought of this when my kids were young. When we bought our first rental property, the kids were seven and nine years old. I didn’t think about doing this until the first one went to college. At that time we made a deal with our kids that we would match anything they put into their retirement plans during their college years. Both of my kids worked during college and made Roth IRA contributions and therefore received our matching funds to spend for college. They got a great jump on their retirement saving.
How about you? Are you doing anything to encourage your children to start saving for retirement at a very young age? The earlier they start, the longer the money gets to compound and grow. Having the government make them millionaires sounds like a nice deal indeed.
41 thoughts on “How to Fund a Million Dollar Roth IRA for Your Child with Government Money”
Upon checking state labor law rules, it appears that only few states follow federal FLSA exemption and allow work in family business for minors below 14.
It’s not “some’ states.
Is it legal to issue 1099-NEC to minor children? An independent contractor status implies the worker making their own decisions, setting their own work hours and no control from the employer. Those criteria can’t be applicable to minors.
Could you confirm it’s OK to report payment to a minor child on 1099-NEC from the parent sole proprietorship?
Inna, You don’t need to use 1099. Just make them an employee.
The bank refused to open an account for payroll for 7 yr kid, how to do it then ?
Just go in and open a bank account for you child. You will likely need to also be on the account as an adult. It has nothing to do with payroll. Simply ask how they open accounts for kids at your bank and they have a plan.
What kind of business should parents own LLC or scorp ? How to employ 9 yr and 3 yr kid and get the tax advantage?
Bil, It doesn’t matter what your business is as long as it is not incorporated. The key is the children must be doing a real job that is appropriate for their ages. The 3 year old can do modeling if you pay them for pictures you use with your business. Look at what your business does and find a real job the kids can do for you. There are always little things to do that don’t require special expertise.
Great post/article! My son just turned 18 and is about to head off to college. What are our options? Thanks
When our kids went to college, we made them a match deal. As long as they were in college, every dollar they earned and put into their IRA or 401(k) or any other retirement plan at a place they worked, we would give them a matching dollar. They could put money in their IRA, which wasn’t available to spend, and we would give them the same money so they could spend it. They got into the habit of funding their retirement early. It gave them a great head start.
Sounds like the kid only needs to record Roth IRA contributions and possibly (depending on income) file taxes. What paperwork does the parent/employer need to do (assuming the simplest scenario, not incorporated etc)? Thanks!
Rich, There is nothing special or different for the parents to do. They pay the kids like normal out of their business account (don’t pay payroll taxes) and write it off like normal expenses. They will need to help the kids set up the Roth IRA at a discount brokerage firm like Vanguard, Fidelity, or Charles Schwab. Then make a deposit to the Roth IRA whenever the kids earn money.
Thanks; I should have been more clear though. If the parents have no official business, what type of business do they need to establish first? Partnership? LLC? S-corporation? Corporation? Or any of the above will work? Thanks!
If a parent has no business, then they don’t get any special bonus. The cool part is the bonus the parents get through their business. Any business you are being taxed for will work as long as it is not a corporation and the parents are the only owners of the business. You can own one rental house and that is a business. It has business write offs that show up on schedule E of your tax return. The kid just needs some earned income to do an IRA and they have more if they get it from mom or dad because they don’t have to pay social security.
I have rental income but I’m extremely confused on how to go about paying my kids for chores I make them do.
Do you need to provide a w2 or 1099 at the end of the year to your kid?
Thanks in advance!
We started doing this for our 5 and 7 year old in 2019. We pay them $1000/year to shred papers in our home office. They are paid as W2 employees of my S-corporation. Would I also need to file a tax return for each child? Is this the best way to set this up to get all the tax benefits? Thanks!
Kat, you don’t have to file a tax return if they earn less than $12,200 a year, but it does make a good backup proof of income for the IRA. Their tax return should be extremely easy to do.
How can you contribute the 3+ tax saving into the Roth, isn’t more than the kid earns?
Leon, you can only contribute up the amount the child earned. If the child earned $3,000 in a year, then you can contribute $3,000 to their Roth IRA. If the chld earned only $1,000 then contribute that.
Been doing this for years. My kids get the “daddy match” on their Roth IRAs. Whatever they earn goes in their Roth IRA, and I give them the same amount of money. Their cousins get a 200% match on their 529 contributions too.
The trick for the young kids (once they’re older they can babysit, mow lawns, and eventually get “real summer jobs) is to find something that pays well that is legitimate to the IRS. I settled on modeling for the website. Child models have a pretty decent hourly rate.
There are lots of ways to employ your kids. I love the modeling idea since all ages can participate. Thanks for your comment
I thought they can only contribute 20% of earned income ?
Rajat, for an IRA you can contribute 100% of earned income.
You’re thinking a SEP-IRA Rajat, for the self employed. But you don’t want your kids to be self-employed. You want to them to be employees of your non-incorporated business so you don’t even have to pay payroll taxes on them.
Why a non-incorporated business?
We both work for a multi-specialty group that files K-1. There is no way for them to work for our group.
We own rentals but not as a real estate holding company.
Could they work for us even if we just hold the properties as individuals? Or technically in a trust.
Anna, Your kids can work for an incorporated business, but they cannot do it without paying standard payroll taxes. Only when they work for their parents, do they avoid the taxes. This is a special benefit the government gives to small businesses. As far as your rentals, your kids can work for them even if they are not in a real estate holding company, and they would still avoid payroll taxes. Being in a trust does not negate this as long as the trust is only the parents.
Does this mean you need to get an EIN and issue them a w2?
Fantastic read. So important for kids to learn the value of contributing. We are starting this for our 7 year old. Age appropriate income. Love it!
Cory, what are some options if I work at a multi-specialty clinic and my earnings are a K-1. Would much kid need to be hired as an employee by HR?
Chelsea, then your kid would be employed like everyone else and not get the special tax breaks but can still do a Roth IRA. When my kids were in college, I told them I would pay them dollar for dollar for everything they put into a retirement account. It motivated them to fill up their accounts at their part time jobs.
Any reason you couldn’t do this with grandkids?
Tom, it’s a great thing to do for your grand kids but you can’t get the special tax advantages of no payroll taxes as that is only for children, not grandchildren. There is a way for your children to form a company that you hire as 1099 and they hire their kids (your grandkids) and can avoid the payroll taxes.
Do the kids need to be a certain age in New York State? Are they filling papers, cleaning the home office? I have a 13,11, 8 and 5 year old.
Roger, each state has different rules. But keep in mind the child should be doing something age appropriate and legitimately contributing to the business. A 2 year old can’t file papers, but a 13 year old can.
Excellent post, I’ve been doing this for 3 years now for my 12 years old daughter, I would like to add that in order to legally avoid FICA taxes, the child’s income has to come out of the parents sole proprietorship (schedule C) as a W-2 income.
Interesting. So I have to generate a W-2 for my kids in order to avoid FICA taxes? I was planning to just create a spreadsheet to document their hours and cut a check from my business checking account. Not enough for IRS?
Anna, Your plan should work fine.
Wow, those numbers are really cool! I just started doing this for my kids. they are younger and will not be working that many hours- but even a little bit adds up- since they have decades stretching out.
Thanks for a great post!
Physician Finance Basics when the kids are little, there are still some things they can do. But your are not likely to get them up to the full IRA amount. But as they grow and learn, they will be able to do more and you will have given them a great head start. Just teaching them to same money is a win.
Brilliant analysis, Cory! I’m definitely doing this!!
Thanks Brent. Your kids will love the results.