Creating Estate Tax Savings For Your Child Using A Roth Ira
By Richard A. Chapo, Fri Dec 9th
Parents must give serious thought to protecting their familythrough estate tax planning. While life insurance and trustsshould be a part of every plan, Roth IRAs can be a simple toolfor passing money to your child on a tax-free basis. Roth IRA
First, we need a quick summary of the Roth IRA. A Roth IRA is anafter-tax retirement vehicle that produces huge tax savingsbecause all tax distributions are tax-free. That statement can abit confusing, so lets break it down. The downside of a Roth IRAis the fact that contributions are not tax deductible as withtraditional IRAs or 401(k)s. The upside of a Roth IRA, however,is that all distributions are tax-free once the person reachesthe age of 59˝. So how can you use a Roth IRA to pass money toyour child?
Opening A Roth IRA For Your Child
One of the biggest keys to retirement planning is “time”. Themore years you spend saving money for retirement, the more youshould have when that blessed day arrives. Imagine if you hadstarted saving for retirement when you were 16. How much biggerwould your retirement nest egg be? What if you purchasedMicrosoft stock in 1990 and watched it split eight times? Okay,that was painful example if you missed that opportunity.Nonetheless, why not do for your child what you didn’t do foryourself?
The fundamental goal of estate planning is to pass as much ofyour estate as possible to your family on a tax-free basis. Youcan transfer relatively small amounts of money to your childnow. If you have a 16 year-old child with a Roth IRA, you cancontribute $4,000 in 2005. That $4,000 is going to grow tax-freefor 43 years and be worth quite a bit. A ten percent returnwould result in the account growing to roughly $200,000 and thefull amount would be distributed tax-free. There are otherpractical advantages to opening a Roth IRA for your child.
As a parent, it is vital that you teach your child
the value ofmoney. Opening a Roth IRA gives you the opportunity to sit downand teach your child the value of saving and investing, insteadof yelling at them to clean their room. While a parental lectureon the need to save money would typically meet with glassy eyesand yawns, your child’s attitude will undoubtedly change whenyou are talking about their money.
Work and Maturity Issues
Before you rush out to open a Roth IRA for your child, you mustdetermine if your child is eligible to open an account. To openan account, your son or daughter must be working at least parttime for an employer that reports their wages to the IRS. Hiringyour child to take out the trash each week is not going to cutit, nor will this strategy work for your 5 year-old. Manyteenagers, however, have summer jobs that should suffice for IRSconsideration. To avoid any trouble, you should consult withyour tax advisor.
A more sublime issue concerns the maturity level of your child.Keep in mind that the Roth IRA will be opened in their name.Your son or daughter will have the legal right to do what theywill with the account. It is strongly suggested that you clearlyexplain the consequences of taking money out of the account[taxes, penalties, being cut out of the will, forced to eathealthy food, grounded for life, etc.] but the decision lieswith them. As difficult as it is, try to be objective inevaluating how you child will react to having money sit in anaccount. If you have doubts, you should probably investigateother tax saving strategies.
Opening a Roth IRA for your child can be a very effective meansof
leveraging your estate. If your child exercises restraint,your relatively
small contribution to their Roth IRA can growinto a sizeable tax-free