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.