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Your Child Needs a Roth This Christmas

No, Roth isnt the latest Parisian fashion designer or a chart-topping emo musician. Your childs Christmas list may look like the inventory of a big box electronics store or the where to buy section in the back of Vogue magazine, but nothing you can bu

By: John Sheflin

No, Roth isn’t the latest Parisian fashion designer or a chart-topping emo musician. Your child’s Christmas list may look like the inventory of a big box electronics store or the where to buy section in the back of Vogue magazine, but nothing you can buy will brighten your child’s future like a Roth IRA.

If your child made $5 mowing the neighbor’s lawn in 2007, you can open a Roth IRA in their name. They must have some earned income from 2007, and household chores don’t count. Investment income doesn’t count either, but if you are self-employed, you can hire your child to work for you and earn a salary.

You can only contribute as much as your child earned, up to $4,000 in 2007. You can open your child’s 2007 Roth IRA anytime up to April 17, 2008, so if they decide to blow all their Christmas money, you can still start their adult financial life in the right direction after all the wrapping is in the trash can. A Roth IRA is different from a standard IRA in that the initial contribution is taxed like your normal income, and that money, and all the money you can earn with that money, is never taxed again. In addition, a Roth IRA doesn't require the owner to withdraw any money at any age, unlike other retirement plans. One drawback of a Roth IRA for some people is the income limit, which varies depending on the tax filing situation, but for example is $160,000 if you're married filing jointly.

Now that some of the basics are out of the way, let’s do a little financial speculation. Let’s say your ten-year-old mowed many lawns and shoveled many driveways, and earned $4,000 in 2007. You provided the added incentive for your child’s earnings by saying you would match whatever was earned and contribute it to a Roth IRA. Starting with that $4,000, if you contribute the maximum ($5,000 in 2008 and beyond) every year until your child is 21, and never again, assuming an 8% return, your child will have over two million dollars at age 59.5, whether they want to retire or not. Of course, if you invest in what you know with a self-directed Roth, that return could be much higher.

While most children (and adults) aren’t too excited about saving for retirement, you can remind your child that the Roth is unique in allowing early withdrawals without penalty as well. For example, once the Roth is 5 years old, and your child is 18, they can withdraw up to $10,000 of the Roth IRA money for a first time home purchase. In addition, the principal can be withdrawn at any time without penalty. Also, if the unthinkable happens, the Roth IRA money can be used for unusual medical expenses as well.

Remember, though, that once your child is 18 (in most states), they gain complete control of the IRA. This means they can choose to take the 10% tax penalty and withdraw all that hard-earned money to buy themselves a big box store or a fashion boutique in Paris. Of course, you don’t have to tell them about this option. We won’t say a thing.

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