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Introduce your kids to the Roth

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in Small Business Tax

Believe it or not, even your teenagers can benefit from tax-saving retirement plans.

Strategy: Have your child contribute part or all of their summer and after-school wages to an IRA. The contributions can grow into a tidy tax-deferred nest egg over time.

Even better, your child can opt for a Roth IRA for greater tax savings. For 2017, the Roth contribution limit is the lesser of your child’s earned income for the year or $5,500.

Here’s the whole story: Unlike contributions to a traditional IRA, you can never deduct the pay-ins to a Roth. But the tax deduction probably won’t do your child much good this year, if any, due to his or her low tax bracket.

On the other hand, future distributions from traditional IRAs are generally taxable, while qualified Roth IRA payouts are federal income-tax free.

Example: Say your 15-year-old daughter earned $3,000 from her summer job. She decides to contribute the $3,000 to an IRA. To keep things simple, let’s say she continues to make annual contributions of $3,000 and earns a return of 8% a year.

Assuming that your daughter will be in the 28% federal tax bracket when she reaches the age of 60, she can expect to receive an after-tax distribution of $999,209. But she actually could pull down $1,252,278 tax free from a Roth—or $253,069 more. (Because all of the income is received in one year, part of the payout would be taxed at the higher tax rates, topping out at 39.6%.)

If your daughter isn’t inclined to contribute her summer job earnings to an IRA, you might consider lending her a helping hand. For instance, you could give her the $3,000 this year to contribute to the Roth IRA. It doesn’t matter that you’re the one actually supplying the cash for the contribution.

You can even fund a Roth IRA for a child who hasn’t worked yet. Suppose your retired mother watches your infant child for you and your spouse. If you pay Mom for her babysitting services, she can set up a Roth IRA for herself and name her grandchild—your infant—as the beneficiary. Then your mother can contribute to the Roth within the annual limits. (For 2017, the maximum contribution for someone age 50 or over is $6,500.)

Tip: Distributions from this Roth can ultimately be stretched out over the child’s life expectancy.

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