Are You Paying Your Kids for Farm Work? Consider a Roth IRA
During the summer months, you likely have seasonal help. If that team includes children or grandchildren, you might want to consider setting up a custodial Roth Individual Retirement Account (IRAs) for them. A young adult can sock away some serious cash in the next decade or three.
A Roth IRA can be similar to a savings account or 529 account, but it offers more flexibility and tax advantages, says Jessica Groskopf, agricultural economist and University of Nebraska Extension educator.
Listen to a “Nebraska FARMcast” with Groskopf:
What is a Roth IRA?
A Roth IRA is a retirement investment account that anyone with earned income can contribute after-tax earnings. Then, the investments within the account grow tax free. A custodial Roth IRA is when a parent or other adult opens one for a minor. At age 18, the child will become the owner of the account.
Roth IRAs can have fees associated with them, Groskopf notes, so be sure you understand those before opening an account.
A Roth IRA is different than a traditional IRA. With traditional IRAs, you deduct contributions now and pay taxes on withdrawals later, while Roth IRAs allow you to pay taxes on contributions now and get tax-free withdrawals later.
“Contributions to a Roth IRA will hopefully be reinvested over time, and then you'll retain earnings on that,” Groskopf says. “A Roth IRA is really interesting because it allows that child to have lots of time to build compound interest on their earnings. The best thing we can do for savings and investments for children is to provide them time.”
A single filer with an adjusted gross income under $140,000 per year, regardless of age, is eligible to contribute to a Roth IRA account. People can contribute up to the annual limit or the total of their earned income, whichever is less. The annual limit for people under age 50 is $6,000 for 2022. You do not have to contribute funds annually.
Earnings can be withdrawn from a Roth IRA tax free after age 59½. If earnings are withdrawn before age 59½, those earnings can be taxed as income and charged a 10% penalty.
But, Groskopf says, there are two key exceptions to the earnings withdraw penalty:
- Earnings can be used to pay qualified education expenses without penalty.
- After a Roth IRA has been funded for five years, $10,000 in earnings can be withdrawn tax-free and penalty-free to buy a first home.
“If we're talking about a younger investor, a Roth IRA might be a really cool tool to use to build wealth and save for things such as education, their first home or ultimately their retirement,” she says.
How Do Roth IRAs Compare to Other Options?
Families often put a child’s earnings in a savings account. This is a safe and secure option, Groskopf notes, but they are likely to have a lower rate of return when compared to a 529 or Roth IRA. Plus, contributions to a traditional savings account are not tax deductible.
A 529 account is a tax-advantage college savings plan. Similar to a Roth IRA, it is an investment account that is likely to earn a higher rate of return than a savings account. 529 accounts have no income limits or annual contribution limits, and anyone can contribute — parents, family members, friends, etc. However, funds must be used for qualified education expenses.
“So, 229 accounts are a bit limited,” Groskopf says. “Maybe you have a child or grandchild who you're not sure of their career path or what type of education they will need in the future. Maybe you put in a significant amount of money, and then they decide on a different path for their life. At least the beneficiary can be changed for these plans.”
As noted above, a Roth IRA combines many of the benefits of a savings account and a 529 account, she says.
“Over the long run, it is likely it will earn a higher rate of return than a traditional savings account,” Groskopf says. “Another advantage of Roth IRAs is that they do not count as an asset for Federal Student Aid.”
Of course, a Roth IRA is an investment account, and investments always carry some level of risk. If you're not comfortable with investing, be sure to work with a certified financial planning professional, CPA, tax preparer and investment adviser, she says. See if it is a fit for your family.
“As soon as a child is earning an income, I would encourage a Roth IRA — even if you have a 529 or another savings account,” Groskopf says. “That really provides them that opportunity to have that investment grow over time.”
Read More: “Roth IRAs for Children Earning a Wage on the Farm” by Jessica Groskopf and Doug Nelson
