Are you trying to come up with a creative gift to buy your teenagers for the holidays this year? Or have you given up and just plan to give them cash? In either case, they might qualify for an alternative gift that effectively keeps on giving for the rest of their lives: a Roth Individual Retirement Account.
For those unfamiliar with a Roth IRA, here’s how it works. All of the income you earn from a job can be contributed to the account up to a certain limit ($6,000 in 2019). Unlike a traditional IRA, you do not get a tax deduction for the contribution. But all the future growth in the account will be available to you tax-free after age 59 1/2, unlike a traditional IRA for which all future withdrawals will be taxed.
What if your children are under age 18? No problem. You simply create a custodial Roth account at any brokerage naming yourself, another parent or even a grandparent as the custodian. It’s still their money, and they will get full control of it after they turn 18.
Call it a win-win
But what does all this have to do with gifting? Most likely your kids have little interest in saving their earnings for a retirement future that’s all but unimaginable right now. They’d probably rather spend whatever they earn. By offering them a gift of cash equal to the amount they would be willing to put into a Roth, you are accomplishing two things: You are providing them with a cash gift for spending, and, perhaps more importantly, you are training your children to begin a savings regimen they will hopefully follow throughout their lives. That’s what I’d call a win-win.
Of course, if your kids did not work at all in 2019, they cannot contribute to a Roth account. But there are many jobs available to teenagers, such as babysitting, lawn mowing and dog walking, that all qualify for Roth contributions, even if the money is paid in cash and not reported to the IRS. Your children should, however, make sure to keep good records of such activities just in case the IRS should stop by for an audit.
Can your children work for you and contribute what you pay them into a Roth? Yes, if you have your own business and they are doing legitimate work. And you’ll even get to deduct the amount paid to your kids as a business expense. But they will have to pay FICA taxes on their earnings, so there is a tradeoff. Less legitimate is contributing money you pay them simply for doing chores around the house. To be certain, consult with your tax accountant before doing anything the IRS might deem suspicious.
Just how valuable is the gift of a Roth account? Suppose your 15-year-old daughter merely earned $300 this year from babysitting and she put it all into a Roth IRA. By the time she is ready to retire at age 65, even at a conservative 6% annual return, that contribution will have grown to more than $5,500. And it will be available to her completely tax-free. All from just a few nights of work in just a single year. Did you ever imagine that babysitting could be so lucrative?