What is a prepaid health plan
What is a 529 plan?
Saving for College with 529 Plans
To Roth or not to Roth 401(k)
The pros and cons of a Roth 401(k) vs. a regular 401(k)
Health Savings Account (HSA)
What is a Health Savings Account (“HSA”)?
A Roth IRA for your kids? Yes, you can.
Here's a tax strategy you haven't heard before: Hire your kids to handle domestic duties and put their pay into a Roth IRA
For two decades, I have promoted the incredible tax savings available to self-employed individuals who hire their children.
In 2005, you can pay each of your children as much as $8,200. (It rises to $8,450 in 2006.) You get to deduct what you paid from your business income -- thus reducing your own income tax, your Medicare tax and, potentially, your Social Security tax. Your children pay zero tax on the income (wiped out by their standard deduction and an IRA contribution). If your children are under age 18, you don't have to pay any payroll taxes -- Social Security, Medicare and unemployment/disability -- on them.
But what if you're not self-employed? Hire your children anyway, and use the proceeds to set up a Roth IRA for each child.
Creating that employee relationship
OK, disclaimer aside, here's how the concept works: You don't have to be in business to hire someone. For years, the IRS has spent millions of dollars educating American taxpayers that if they hire someone to clean their homes, they have created an employee-employer relationship, and the payments are wages subject to Social Security tax.
Clearly then, you don't have to have a business to create an employee relationship and for the dollars paid to that employee to constitute wages. So if you hire your child -- and document it -- it's compensation income to your child. It's exactly the kind of compensation income that qualifies for a Roth IRA. Remember that the only way someone can set up an IRA is if they earn income. (There is a provision for a spousal IRA, as the government rightly figures that a work-at-home spouse, is by definition, working.)
Back to the youngsters. Hire your children to clean their rooms, wash the dishes and mow the lawn. These are the chores for which, in the past, you have given them their allowance. But now, actually pay them specifically for what they do. Make it clearly income for services rendered, and actually give them a W-2 at the end of the year.
You could pay them at least $4,000 during the year -- and at least that amount in 2006. The reason this is more advantageous than, say, setting up a custodial account in which the money is put into an account for your child, is that the income that's earned while in the account is taxed later at the child's marginal tax rate. Similarly, you could give the money to your child as a gift, but any income that's earned is taxed at the parent's marginal tax rate until the child is at least 14 years old. So you just can't save as much
as you can with this plan.
Socking away the money
Now, let's see what happens when we convert "allowances" into "compensation."
First, the child will file tax returns. But, because this is "earned" income, it can be offset by his standard deduction of $5,000 in 2005 (or $5,150 in 2006) ). So, he won't owe any taxes. Moreover, if you provide more than half of their support, you can still claim them as a dependent and they still qualify for the exemption on your return.
If the children are under 18, because they are working for their unincorporated parent, no Social Security or Medicare taxes have to be paid. Since they are working for their parents at home, no child labor laws are violated.
Then, take the $4,000 in 2005 income and put it in a Roth IRA. (The amount is the same for 2006.) All earnings in a Roth IRA are tax-free. So you haven't saved any taxes on this year's income, but you've socked away money that your child can take out tax-free several years down the road.
How can you do this? The U.S. Tax Court has validated a parent hiring his 7-year-old son to work for his business and allowed the deduction for reasonable wages paid. So, in a non-business setting, we know we can start with children who are at least 7 years old. (No hiring of infants, please.)
If your child invests $4,000 from age 7 to 18, and invests it under the Roth umbrella at 8% per year, compounded monthly, that child will have accumulated about $69,000 by age 18.
Now, if you leave all of the money untouched, but contribute nothing after your child hits 18, by the time the child is 60, he or she will have accumulated more than $2.4 million that can be withdrawn tax-free! (No, you can't take it back. You've set the IRA up in the child's name, remember?)
Even if you cut those numbers in half, you still have created, for less than $5.50 a day, financial independence for your child.
Trying to find a hole
Does it work? You bet. The secret is to convert "gifts" into "compensation" to qualify for the Roth IRA contribution. Unlike other investments, the Roth account grows tax-free.
Is it morally right? I think so. I feel a fiduciary obligation to do what I can to ensure my children's (I have three) financial independence. Currently, the nation's tax laws allow us, as taxpayers, to do this. If Congress thinks the law is wrong or in error, it can change the law.
I've asked several tax experts to find a hole in my analysis. None has been able to do so. I'm putting my professional reputation on the line for this, because the goal is to reduce our taxes -- or, at least, to find ways to increase our income.
The fact that I believe this tax strategy is legal reflects, in part, how complex our nation's tax law system has become. I have said it before and will say it again: It's time to simplify the tax laws.Source: www.xiaoyaozi.com