By Megan Sayles
AFRO Business Writer
It’s common for young adults to start thinking about retirement plans once they begin working full-time. But saving can start much earlier, especially if parents hire their children.
Investment brokerages allow parents and legal guardians to open Roth Individual Retirement Accounts (IRAs) on behalf of their children no matter their age. The only requirement is that the child has earned income.
Starting young also means the child has more time for their money to compound, which allows them to earn interest on their principal investment and on accumulated interest.
“The younger you save, even if it’s not as much money as you’d have when you’re older, the more incredible the time horizon for compounding interest is,” said Cathleen Davis-Whitmore, IRA product manager for Wells Fargo. “In a Roth, earnings are going to grow tax-free instead of just tax-deferred like in a traditional IRA.”
According to the IRS, if a parent owns a sole proprietorship and pays their child less than the standard deduction, which is $13,850 for 2023, the child does not have to pay taxes or even file a tax return. However, the IRS also states that if a parent owns a corporation and hires their child, the child will need to pay income tax withholding, Social Security taxes, Medicare taxes and Federal Unemployment Act taxes.
In both cases, parents can write off the child’s wage as a business expense and reduce their taxable income.
The maximum annual contribution that can be made to the child’s Roth IRA is $6,500, and annual rates of return typically range from 7 to 10 percent.
Davis-Whitmore said although saving for retirement may be a foreign concept to children, it’s important to ensure they have an understanding of the importance of saving as early as possible. Once they’ve gained that foundation, they will carry their saving habits into adulthood.
“Retirement savings is a huge issue for people today. Looking at statistics over the past few years for the baby boomer population, more than 50 percent of them only had $50,000 saved,” said Davis-Whitmore. “The difference between those who save early and those who wait is huge.”
In order for a parent to put their child on the payroll, there are some guidelines to follow.
Accountant and tax advisor Tenere Robertson said the child must be a real employee. Parents should also write a job description for their children. It’s important that parents also refrain from showing favoritism to their children; they cannot pay them an unreasonable salary. Also, children
can’t be paid for chores; they must be doing legitimate work.
“The job has to be ordinary and necessary for your industry. I own a tax and accounting firm. I could not hire my son to wash my car and say it’s a business expense, but I coud hire my son to run my scheduler, greet clients or be an assistant,” said Robertson, who owns T. Robertson and Associates. “It also has to be age appropriate for the child.”
Robertson also said that parents cannot just pay the child a one-time, lump-sum deposit. They need to pay them throughout the year.
“I always encourage my clients to make sure that they have a savings account, a Roth IRA or a college savings plan because you want to show that the contributions are going in. A lot of times you might think you can just make a one-time lump sum deposit, but that’s not how it works in real life,” said Robertson. “You need to pay the child along the way.”
Since it may be hard to convince children to save their money, Robertson said parents can incentivize them by offering to match their contributions to a Roth IRA. They just have to ensure they do not exceed the annual maximum contribution.
“The average child might get hired at age 10. If that child was to contribute $6,500 a year between him and the parent to a Roth IRA for 55 years, they would have almost $4 million,” said Robertson. “Technically, that child would be a millionaire by the time they were 50, and I am being modest because that’s a 6 percent interest rate.”
If a parent does decide to hire his/her child, it’s critical that they follow their state’s labor laws, which limit their hours and the times they can work, according to Robertson. She added that hiring your child can teach children about the value of money and hard work.
“Teach your children that you don’t get to just make money and celebrate right then and there. You have to save for a rainy day,” said Robertson. “It’s so much easier to get to a million if you do it in small steps because it’s not going to happen for most of us instantly.”
Megan Sayles is a Report for America Corps member.