I’ve heard this is a good way to set your kid up for success and take advantage of compounding. One of the parts I always get caught up on when looking into it, is that your kid needs some form of taxable income, and whatever they contribute, you can match it.
If you have a child that is just a couple years old, how do you accomplish this? I can’t just say I pay her $3000 a year for picking a book to read each night…or can I?
Waiting for a reply
I’m no expert, but I’m gonna say no. Your child would need to have earned income. Allowances or getting paid for household chores isn’t going to cut it.
Your kid would need reported W2 income to be eligible. Start a 529 plan instead.
Agreed that a 529 seems to be the right answer. Be aware that it does have its own rules and limitations (main goal is for it to be used towards education), which I believe can be broken for a percentage fee.
Right. I set up one of these when my child was born, but was looking for other options as well. The 529 will probably reach it’s peak right before college, where as an IRA will (potentially) grow for another 40 years
It doesn’t have to be W-2 income, but that’s a lot easier than other options to justify to the IRS. But as long as the money is coming from someone not directly related to the child for work actually done, you don’t need a W-2.
So if the child does modeling or other contract work, it counts. Birthday money and allowances do not.
I see. So how do most people do this for their kids? Do they report their income and have their children pay taxes?
You have to wait until your kid has earned income, and the max your kid can contribute is there earned income or the IRA max, whichever is lower.
But an IRA isn’t the only way to help your kid save for the future. Here are some other options:
- 529 - no taxes on gains if used for education expenses
- UTMA - basically a custodial account with tax advantages; the money will be in their name, so it could impact eligibility for financial aid
- trust fund - a lot more flexibility for the parent on when and how the child can use the funds
- Treasury bonds, like ibonds
I’m sure there are others.
Our plan is a 529 and an informal offer to match my kids’ IRA contributions until the leave the house. We’ll also offer to help in other ways, like a car for school (if needed), a down payment on a house (if wanted), etc. But aside from matching their IRA, we plan to retain control.
My state gives me 10% back as tax refund for contributing up to $5000 a year to my kids 529.
