Roth IRA for kids

[Coronita]

Going over my taxes….I was just thinking….There doesn’t seem to be a minimum age requirement for a Roth IRA, based on prelim googling. Is anyone else wacko enough like me to have considered this?

It’s a long shot that rules won’t change and somehow in the distant future maybe uncle sam will figure out a way to somehow tax a Roth….

However, I though about this in addition or instead of a 529 or regular UGMA custodian account because:

*Capital gains and dividends would all be tax free (for now), and in the worst case tax deferred, if uncle sam changes things.

*For a Roth IRA, contributions to that account can be withdrawn without paying taxes or a penalty, since it was money that was taxed already anyway. Only earnings (capital gains, dividends,etc) is subject to taxes (and possibly penalties) for early withdraw.

*Under certain circumstances, I think even earnings can be drawn early without paying the tax penalty for qualified educational expenses. (You might owe ordinary income taxes/capital gains on it, but no additional penalty..) http://www.irs.gov/publications/p970/ch09.html.

*I think your kid can also withdraw up to $10k towards their first home purchase without incurring the tax penalty.

*Starting early, you get a chance at tax free compounding for a long time. So you can make a tiny, barely noticeable contribution now, and hopefully with compounding for a decades, it will grow effortlessly.

*Unlike for a your own Roth, your income won’t limit how much you can contribute to their Roth, since how much you can contribute to their Roth depends on how much income they earned that year. The drawback is they have to have some earned income (IE a job)

So if one was going to be gifting money to their kids every year anyway below the estate tax limit thresholds….instead of a regular custodian account (for which any sort of capital gains/dividend you would still need to pay taxes on now), putting it in a Roth for them would give them a starting retirement seed, and allow compounding to work tax free for a long time, and still leave the option to use a portion of the money for major expenses before their retirement, without incurring additional tax penalties for early withdraw of that portion versus a regular custodian account…(assuming they have earned income that year to allow you to contribute to a Roth)

Thoughts?

[Coronita]

Issues/Drawbacks:

* Money will be tied up for long time with a stiff tax penalty for early withdraw on earnings…except withdraw for qualified expenses for education, first home purchase, and hardship withdraw.

* This would probably mess up financial aid, but it’s a moot point for those of us that weren’t going to quality for this anyway.

* Your kid needs to earn an income to be able to contribute to a Roth. What you can contribute is limited to what they earn that year or $5500, whichever is lower.

* I don’t know what the tax implications would be if your kid unexpectedly passes away early (hope that doesn’t happen)

* Uncle sam can change the tax laws

* Marriage. Can this remain separate property?

[The-Shoveler]

Dang I wish someone had done that for me LOL.

[bearishgurl]

Don’t do it, flu. An IRA opened for a kid will likely be separate property in marriage IF the kid doesn’t withdraw any or all of it early and “commingle” it but your kid is still young and a lot of things could happen to YOU between now and the time your kid applies for college.

Just being pragmatic here.

Who knows? You might have a lower income for the FAFSA by the time you decide to fill one out. If your kid turns out NOT to be Ivy/Elite material, you may want to fill out the FAFSA for her to see if any aid is available for her for a state school. You won’t have to report all your “locked-up holdings” on a FAFSA as you would other forms for an elite private school.

And do YOU have long-term care insurance?

Just wondering …..

[SK in CV]

It’s a great idea. Almost no downside. If I had lots of extra money and my kids didn’t need today what little I do give them, I’d do it in a heartbeat. My brother (a managing director at a national tax and consulting firm) who does have plenty extra and doesn’t need to worry about his own retirement, has been doing it for his two daughters for more than a decade.

[Coronita]

[quote=SK in CV]It’s a great idea. Almost no downside. If I had lots of extra money and my kids didn’t need today what little I do give them, I’d do it in a heartbeat. My brother (a managing director at a national tax and consulting firm) who does have plenty extra and doesn’t need to worry about his own retirement, has been doing it for his two daughters for more than a decade.[/quote]

I was hoping you would chime in on this. Thank you.
Now the bigger issue is that I need to figure out. How do I give my kid a “job” at this age…lol….

You said “almost no downside…”

Ok, almost… What are the downsides in your opinion…..

[SK in CV]

[quote=flu][quote=SK in CV]It’s a great idea. Almost no downside. If I had lots of extra money and my kids didn’t need today what little I do give them, I’d do it in a heartbeat. My brother (a managing director at a national tax and consulting firm) who does have plenty extra and doesn’t need to worry about his own retirement, has been doing it for his two daughters for more than a decade.[/quote]

I was hoping you would chime in on this. Thank you.
Now the bigger issue is that I need to figure out. How do I give my kid a “job” at this age…lol….

You said “almost no downside…”

Ok, almost… What are the downsides in your opinion…..[/quote]

The accounts belong to the kids. If they’re over 18, they don’t need your permission to take the money out. We always hope our kids are going to act responsibly, but we never know for sure. Other than that possibility, I can’t think of any downside.

[Coronita]

[quote=SK in CV][quote=flu][quote=SK in CV]It’s a great idea. Almost no downside. If I had lots of extra money and my kids didn’t need today what little I do give them, I’d do it in a heartbeat. My brother (a managing director at a national tax and consulting firm) who does have plenty extra and doesn’t need to worry about his own retirement, has been doing it for his two daughters for more than a decade.[/quote]

I was hoping you would chime in on this. Thank you.
Now the bigger issue is that I need to figure out. How do I give my kid a “job” at this age…lol….

You said “almost no downside…”

Ok, almost… What are the downsides in your opinion…..[/quote]

The accounts belong to the kids. If they’re over 18, they don’t need your permission to take the money out. We always hope our kids are going to act responsibly, but we never know for sure. Other than that possibility, I can’t think of any downside.[/quote]

IF it’s the same rules as for UTMA, then I think in CA the age is 21. I guess the difference is that for a UTMA/UGMA, until that age, I think technically youcan withdraw from that account, as long as that withdraw is “for their benefit”. So if your kid is out of control at age 20, you have that option. I guess for the roth, that wouldn’t be possible, at least for the earnings portion without paying the penalty.

[skerzz]

SK,

Does your brother work for a firm in San Diego?

[SK in CV]

No. He left SD almost 40 years ago.

[bearishgurl]

Back to the “marriage” thing, for example, your kid could get married and then “take a withdrawal” out of $10K of their IRA funds for a downpayment on their first home (that you invested for them when they were a minor).

http://www.nolo.com/legal-encyclopedia/using-ira-make-house-down-payment.html

Then take title to that home in “joint tenancy” with their spouse and subsequently get divorced and lose 1/2 their “equity” (assuming there is any equity left to split at that time).

I guess this is the same as gifting your married child $10K (or more) to help with a downpayment on their home and they they subsequently lose it in SS, FC or a forced “divorce sale.”

I’ve just seen a lot of stuff like this this in my day and its not pretty. Not related to IRA’s, the worst things I’ve seen happen were to heirs of free and clear CA homes (with extremely low taxes) who got married and then later had to use their spouse’s income to take out a mortgage on their inherited home which was large enough to improve the home (or invest in spouse’s business, their kids’ college or for a variety of reasons). The mortgage application triggered their lender to require a “quitclaim deed” be executed from the heir-spouse to both spouses as a condition of granting the mortgage, due to the “heir-spouse” having little or no income of their own to qualify for it by themselves and so the heir-spouse cooperates and executes the quit-claim.

Later, the couple gets divorced and the “heir spouse” is unable to buy their spouse out of the property. They end up recovering very little equity from the forced sale of their former parent(s) home because it is now mortgaged (in some cases repeatedly) and half of it now belongs to their spouse, who lived with them in the home while married and also signed the note(s) on the mortgage(s) they took out together. Of course, the heir spouse’s ultra-low assessment is also lost upon sale.

Even though unemployed/underemployed at the time of marriage, the “heir spouse” in many cases would have been far better off to work at least part-time during the marriage and pay ALL the bills related to their “inherited” property (taxes and insurance but not necessarily utilities) and pay for any repairs that it needed out of pocket. They should have never involved their spouse whatsoever in the direct expenses of the home. Instead, they essentially (unwisely) commingled the equity from their inherited homes to receive large amounts of cash from them.

I’m still in touch with most of these people from time to time (all but one were females) and two are them are now 60-65 years old and virtually “homeless” (renting rooms in other’s homes).

That wasn’t what their parent(s) intended in leaving their child(ren) their home.

I think I posted somewhere here a while back that none of us has any idea WHO our kids might marry (and are powerless to stop an adult’s marriage which we may think it wrong for them) or how that marriage will turn out.

I like the idea of leaving in trust money to (currently young) heirs in stages, such as appointing a fiduciary to pay college expenses at 18 years old, payment 2 at 22-25 years old and payment 3 (the largest payment) at 30 years old or older. Even a “staggered-payment trust” as described above can’t control everything but it can teach an immature spendthrift kid how to budget and save, since there are several years between payments and no way to obtain an “advance” in between payments.

I guess an IRA gifted to your kid from investments you made while they were a minor would work out okay IF your kid was well employed directly out of college and all their needs were taken care of. I just feel that the kid would take withdrawals (and the subsequent tax hit where applicable) IF they KNEW about the IRA and felt that they “needed” anything at all (i.e. newer vehicle, overseas trip, or help with downpayment on first home, etc). And they may not tell their parent(s) about it if they do … that is, until they have to file their tax return and are shocked as to how much they owe :-0

[SK in CV]

BG, this sounds like horrible divorce representation. Under the scenario you described, absent a specific waiver of reimbursement, the value of the home contributed to the community would be reimbursable to the contributing spouse, irrespective of how the home was transferred to the community.

These kinds of problems would be easily avoidable in the case of a Roth (or other self-directed retirement plan). Even employer sponsored plan equity is separate property, to the extent it was earned prior to marriage.

[Coronita]

[quote=SK in CV]BG, this sounds like horrible divorce representation. Under the scenario you described, absent a specific waiver of reimbursement, the value of the home contributed to the community would be reimbursable to the contributing spouse, irrespective of how the home was transferred to the community.

These kinds of problems would be easily avoidable in the case of a Roth (or other self-directed retirement plan). Even employer sponsored plan equity is separate property, to the extent it was earned prior to marriage.[/quote]

I thought that was the case, but wasn’t sure…I guess I’ll talk to an estate attorney as well as a CPA when I get around to it 🙂 I’m just looking for preliminary information (brainstorming if you may call it). The actual technical details, I’ll discuss with a paid pro(s)…

Merci!

[bearishgurl]

[quote=SK in CV]BG, this sounds like horrible divorce representation. Under the scenario you described, absent a specific waiver of reimbursement, the value of the home contributed to the community would be reimbursable to the contributing spouse, irrespective of how the home was transferred to the community.

These kinds of problems would be easily avoidable in the case of a Roth (or other self-directed retirement plan). Even employer sponsored plan equity is separate property, to the extent it was earned prior to marriage.[/quote]SK, I see where a statement in my post could have been miscontrued:

[quote=bearishgurl]. . . They end up recovering very little equity from the forced sale of their former parent(s) home because it is now mortgaged (in some cases repeatedly) and half of it now belongs to their spouse, who lived with them in the home while married and also signed the note(s) on the mortgage(s) they took out together. . .[/quote]

SK, I DO realize that in CA the non-heir spouse on title receives a portion of the heir-spouse’s ownership of their inherited property’s equity in a divorce based primarily upon how long ago they inherited it prior to quitclaiming it to both spouses.

The individuals I referred to here were ALL represented by counsel during the settlement of their divorces (I only learned about their problems with losing their properties to SS or FC AFTER they were already divorced). In two of the cases, I worked on the divorce myself and submitted that work to their attorney for filing and service.

Example of what I have found to be a common scenario in SD: Married in 1975 (first marriage for both). Couple are renters until 1979, when one spouse “inherits” the family home of ~1300 sf after last parent died. Heir contracted to purchase brother’s half for $17K at 10% per annum in installments over 4 years (a “bargain” at the time). By 1986, heir-spouse owns home free and clear and has three growing kids and feel that they are growing out of their house so they seek to mortgage their home to obtain funds for a remodel. The owner (heir-spouse) is told they don’t have enough income by themselves to qualify for the ~$60K mortgage they are seeking (mtg interest rates were much higher back then). So they cooperate with mtg broker and “quitclaim” their “inherited” property to themselves and their spouse (who is working FT) in order to qualify for the loan. Heir’s spouse signs the note and TD along with heir and after receiving the proceeds, they commence work on a ~500 sf addition to better accommodate their family. The work is finished less than a year later and the couple end up refinancing “cash out” four more times (in ’89, ’92, ’93 and 2003) to enhance their lifestyle (the “heir spouse” is still bringing in little to no income). With their kids grown and gone, the couple ends up separating in 2008 and divorcing in 2009. Here, the non-heir spouse’s portion of the home equity was complicated by them being able to prove (with old paystubs) that they helped the heir-spouse buy out their brother’s equity in those four years long ago at a time when both spouses were still working. Upon settlement, a portion of the non-heir spouse’s “payoff money” to heir’s brother was attributed to “rent” because they had to live somewhere during those four years. Here, the non-heir spouse ended up receiving an award of 48% of the equity of the family home (now in the “community”) which was calculated as follows: 29 years ownership by heir. 22 years ownership by heir’s spouse + 2 years ownership added (for helping to pay heir’s brother off for 4 years) totaling 24 years ownership by heir’s spouse. The property sold in 2010 where heir received ~55% and heir’s spouse received ~45% of the ~$25K of sales proceeds from escrow (after liens were satisfied).

This isn’t the story of either female I was referring to but a (rather convoluted) version of what SK is likely referring to here. In most cases, the non-heir spouse (on title) is awarded a lesser percentage of the heir-spouse’s inherited property upon divorce. I think the above story illustrates that truth is often stranger than fiction when “life happens” over the years.

Those two “boomer” females I was referring to here had “inherited” their family home (in 2000 and 1997) during a time when they were both single (divorced). Both remarried soon after inheriting their family home (several months to 3 yrs later). When those marriages ended in divorce, they and their spouses had already borrowed so much of the property’s equity (in two or more cash-out refis and a HELOC) that there was very little equity left to split in one instance. In the other instance, the couple lost their home to FC.

It is especially sad for the 1st heir, who ended up receiving only ~$10K equity from the sale of her childhood home post-divorce which she “inherited” free and clear about 8-9 years earlier (she was still working after her last parent died and was able to buy her sibling out of their half). Both heirs (unwisely) co-mingled their inherited CA property with a new spouse in order to receive cash from its equity for a variety of purposes. The second heir and her spouse simply went though the equity of the inherited home in >3 years and then squatted for a time before the “heir” was finally evicted by her foreclosing lender while she was living alone in it with no income coming in (after her spouse had already left the home).

IMO, this wouldn’t have happened to either heir if they had kept working after remarrying … at least part time, and kept a separate checking account to pay the property taxes, homeowner’s insurance and for all the maintenance, repairs and any remodeling of their “inherited” property from. Even if their spouse did any of this work (non-licensed contractor spouse), he should have been paid for it. If they cut a cashier’s check to their spouse for the fair-market value of the work he performed and kept the carbon copy, even if the husband kept the check without cashing it or later returned the check to the wife uncashed (for illustration purposes only – roles could be reversed), it is proof positive of the heir-wife’s intention was to pay the husband a set amount of money for the work he performed on her property. This could serve to successfully block a later claim of a portion of “ownership” by the non-heir spouse in the case of a divorce.

The above scenarios were all absent a prenup (which way too many people don’t see the need to pursue prior to remarriage … to their eventual peril, imho).

[end hijack]

[carlsbadworker]

I think it is great. It certainly beats UGMA or 529. But I think you need to wait until they really start to earn their income. 1) It is really the right thing to do rather than lying to IRS 2) IRS could easily audit it if you claim that your two-year-old is making $5K a year.

The order of importance to me is:
1) Teach kids about money
2) Teach kids about saving money (i.e. the value of having money to spend when they want it)
3) Teach kids about how to earn money (I don’t like monthly stipend, I want my kids learn how to earn money by meeting people’s need, rather than becoming an entitlement). So, maybe $1 for taking out trash daily, I haven’t thought through this yet. It will start with earning my money, but eventually earning money outside by looking for “work” opportunity (e.g. I can teach them writing codes and they can do freelancing).
4) Once they start earning money from the outside world, 80% of their money will need to go to Roth. I can cover their little expenses and co-pay for their bigger expenses up to a limit (kind of like insurance company to them, without insurance premium, again details not hashing out yet). Of course, they will have expenses that they don’t want me to know about (not “insurance” claimable) which they can use their 20%.
5) I won’t worry about they being less illegible for government handouts and scholarships. If they learn to how to become financially more independent, with enough assets and income ability. Tax and government handouts are secondary. Get the first order of business right.

[Author]

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