Are Your Children Putting Their Babysitting Earnings to Work?

Are Your Children Putting Their Babysitting Earnings to Work?

I’ve written often about the importance of saving for retirement. And also about the value of starting as early as possible to maximize the compounding of your returns over time. Well, why not start saving as a child? With a little help from you, even your younger children can start a Roth IRA to shelter lots of retirement income from future taxes. The approach is quite simple. You create a Custodial or Guardian Roth IRA for your child. The money the child earns from babysitting, lawn mowing, pet walking, or any of the host of jobs available to children can be put into the Roth. Once there, it can be invested and will grow tax free over your child’s entire lifetime. That’s a sweet deal!

The maximum contribution to a Roth in any year is $5,000, but the IRS allows you to contribute up to 100% of your income. That shouldn’t be a problem for your children since they don’t need the money anyway. Of course, many children would prefer to spend their earnings on toys or entertainment rather than save it. By and large that’s a good thing, because it teaches them about budgeting and about the relationship between earnings and expenses. This is where you can help by matching some or all of their earnings and putting the matching funds into the Roth. As long as you don’t put in more than they’ve earned, the IRS doesn’t care. Technically they are putting their earned income into the Roth, and you are gifting them a matching amount for spending or other purposes. Since gifts less than $13,000 don’t need to be reported to the IRS, there’s nothing to report other than the Roth contribution.

You might be wondering whether or not it would make more sense to invest the earnings in an IRA rather than in a Roth, since contributions to an IRA (unlike a Roth) are tax deductible. The answer is no. That’s because the first $5,950 of the child’s earned income won’t be taxed in any case since it’s less than the standard deduction. Why not therefore take advantage of the Roth with its lifetime tax-free growth.

Can your child work for you and put his or her earnings into a Roth? Yes if you have your own business and your child is doing legitimate work like stuffing envelopes or something similar. And you’ll even get to deduct the amount paid to your child as a business expense.

How about earnings for chores done around the house? That gets a bit stickier. To be sure, consult with your tax accountant before doing anything the IRS might deem suspicious.

Just how valuable is saving and investing this early in life? Suppose your daughter earns just $100 each year from babysitting, starting when she is age 10 and continuing until she turns 18, puts the money into a Roth each year, and is able to earn a reasonably conservative 8% per year. By the time she is ready to retire at age 65, she will have accumulated nearly fifty thousand dollars from that $800 worth of income. And withdrawing it will be completely tax free!

Who said babysitting wasn’t lucrative?

Leave a Reply

Your email address will not be published.

This site uses Akismet to reduce spam. Learn how your comment data is processed.