Peter's Roth IRA

By Clifton Linton
Senior Writer, mPower

In This Story Peter's Plans Matching Contributions Tax Implications It Has to Be Earned The Payoff Years

There's an old Chicago saying that goes "vote early and often." The same concept applies to retirement planning, if you just change "vote" to "save."

Time and interest compounding are the two biggest allies of retirement savers. If you could start in your teens or earlier, think of all the time your money would have to grow. As long as you've got earned income, it's possible with a Roth IRA.

minute: read this article at a glance.

Like many working Americans, Peter Gustafson finds it tough to scrape together enough money to set aside in his retirement account.

Although, unlike most Americans, it's probably not all that important if he misses contributing for a year. At nine years old, he qualifies as one of the youngest working stiffs to start saving for his golden years.

At the suggestion of his parents, Peter wants to put the money he earns cutting four neighbors' lawns into a Roth IRA. Peter's parents think it is wise to teach him not only the ins and outs of running his own business, but also the options available for dealing with the money he earns. Plus, by starting early with a modest contribution, Peter will be able to build a healthy nest egg by retirement.

As long as he has earned income, Peter can contribute it to a Roth IRA. But, since Peter is a minor, there are a few rules his parents need to follow to avoid running afoul of the IRS.

Peter's Plans

Peter's parents, Kevin Gustafson and Betsy Lidecker, aren't Type-A personalities pushing him to be a superkid. Betsy, a mortgage broker, and Kevin, a security system rep, are just two, well-grounded parents trying to pass on good money habits to their only child. They're hoping a Roth IRA will be a good tool for this.

"My own realization that I got started much later than I should have, to put money aside for retirement, has been a motivating force to get my son started now," Kevin said.

And, don't get the idea that Peter's a budding Michael Milken. Like any nine-year-old boy, his main passions are model airplanes, baseball, and video games. One of his goals for the summer is to become the pitcher for his Little League team.

But, Peter also likes to work. Last year, when he earned $320 from his lawn business, Peter learned two lessons. The first was it costs money to run a business. When his mower broke last year, he chipped in half the cost of a $40 repair.

The second was the value of saving. "Last year when he made his money, we let him spend some and (made him) save some," Leidecker said.

Financial planners applaud Kevin and Betsy's strategy.

"If you incorporate matching with a child, it gives them an incentive to save." —Carrie Coghill, certified financial planner and senior vice president of D.B. Root & Co.

"I think (this savings strategy) teaches a lot of valuable lessons," said Robert Weagley, a certified financial planner and associate professor of consumer and family economics at the University of Missouri. Peter will learn the financial golden rule that "we don't reach the goals we have unless we do without," Weagley added.

Admittedly, retirement planning is a very esoteric concept for a nine-year old, but Peter is starting to grasp the concepts of saving and delayed gratification. Last year, at the end of the summer, he had amassed enough money to buy some of the more expensive Pokemon trading cards through an online auction.

And this year? "I want a Sega Dreamcast," he shyly replied.

Matching Contributions

Peter's parents are trying to gently nudge him to boost the amount he saves this summer compared with last summer, when he put away $175.

They realize they are walking a fine line between teaching a fun lesson and creating a situation where Peter resents them for making him put all his money away in savings. So, they've devised a strategy to make it more palatable to give up all his money to a Roth IRA — matching contributions. For every dollar Peter saves, they plan to provide a matching contribution for him to do with as he wants. But, they're not just emptying their wallets. "We would match up to a certain percentage," Leidecker said.

That's a great strategy, said Carrie Coghill, certified financial planner and senior vice president of D.B. Root & Co., of Pittsburgh. "If you incorporate matching with a child, it gives them an incentive to save," she said.

Peter currently cuts four lawns, one worth $10 a cut, two worth $7, and one worth $3. If he cuts each lawn every week, in another 18 weeks he'll earn $486. Add that to the $120 he's made this year, and he could end up with $606 to potentially save.

Tax Implications

According to IRS tax rules for children and dependents, Peter would have to file a tax return if his only income consists of earned income of $4,300 or more. If he only has unearned income, such as from interest or dividends, the filing threshold falls to $700.

Since Peter has a few shares of McDonalds Corp. stock, which does pay dividends, he likely will have earned and unearned income and need to use an IRS worksheet to figure out if he will need to file. He probably won't owe any personal income tax, though.

For more on the tax rules for children and dependents read Publication 929 at the IRS website.

Filing a tax return could actually be helpful, because it will enable Peter to prove he has earned income, which is a requirement for opening a Roth IRA, said William Stecker, certified financial planner and owner of the Marble Group, Ltd. of Divide, Colo.

The maximum a person can contribute to a traditional or Roth IRA each year is $2,000 or the amount of his or her earned income for that year, whichever is less. So if you earn $600, for example, that's all you can contribute.

Even if Peter doesn't have to file a tax return, he can still open a Roth IRA and contribute up to the amount of his earned income, said Coghill. "You aren't required to file a tax return just because you are making a contribution," she added.

However, it's a good idea to keep records of where the money came from and for what services, in case the IRS comes calling.

The Income Has to Be Earned

Peter's lawn cutting business is a two-person show. Kevin admits, "I'm his salesman."

But, Peter provides the brawn, pushing the lawn mower over his neighbors' yards.

That's the most important point in making this saving strategy succeed. The only way the government will allow Peter to open a Roth IRA is if he earns the money he contributes. In other words, Peter has to do work to get the money.

Dividends, interest income, and allowances don't count as earned income and therefore can't be contributed to a Roth IRA. For that reason, in case there's an IRS audit, it's important that Peter keep records of what he earned, when he earned it, and for what job, Coghill said.

The IRS keeps its eyes open for wealthy parents who try to use their kids as tax shelters. If you try to funnel thousands of dollars into a child's IRA so you can get a tax break, when the child didn't earn that much money, the IRS is watching for you, Stecker said.

The maximum a person can contribute to a traditional or Roth IRA each year is $2,000 or the amount of his or her earned income for that year, whichever is less.

Peter won't be able to open a Roth IRA without his parents' help. They'll need to sign the account applications as his guardians. At this point, Kevin is looking to invest the money in a mutual fund, on Peter's behalf.

The one concern that planners voiced is what happens when Peter reaches the age of majority, at 18. At that point, he will have full access to the money to do with as he wants. Coghill said she would encourage him to hold on to the money as long as possible.

Since Roth IRA contributions are made with after-tax money, you can withdraw them at any time without paying a penalty, once you've had the account for at least five years. Interest earned on the contributions, however, are subject to an early withdrawal penalty if pulled out prior to age 59½.

The Payoff Years

What Peter and his parents are trying to do by opening a Roth IRA at this early age is to take advantage of interest compounding. Admittedly, Peter may have some hefty expenses to cover long before retirement — college, cars, or a first-home purchase. But, if he can set the money aside and not touch it, this small investment now could pay huge dividends down the road.

Suppose Peter opened his Roth IRA this year with a $600 contribution and never contributed another dime. At age 65, assuming a 10% rate of return, he would have about $125,000.

But, if he continued to add to his account, at a rate of $600 a year, assuming the same 10% rate of return, his final balance at age 65 would be about $1.37 million.

Stecker questions whether Leidecker and Gustafson are doing the right thing. What about college? "It's not smart to open a Roth IRA unless there's a uniform gift to minors account (UGMA) in place for college expenses," Stecker said.

A UGMA is a mechanism created through the tax code that allows an individual to make a gift of $10,000 or less during a single year to another person to use as he or she wants. It's a way to reduce the taxable estate. However, many states require such gifts to be placed in a trust or a custodial account to be managed by a guardian. If you're interested in UGMAs, consult with a financial planner for additional details.

Gustafson and Leidecker have Peter's college expenses partially covered. To date, they have $25,000 in a savings account just for that purpose.

Check back with 401Kafé.com in October to see if Peter managed to raise his money and open his account ...

The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.

Peter's Roth IRA

By Clifton Linton
Senior Writer, mPower

In This Story Peter's Plans Matching Contributions Tax Implications It Has to Be Earned The Payoff Years

There's an old Chicago saying that goes "vote early and often." The same concept applies to retirement planning, if you just change "vote" to "save."

Time and interest compounding are the two biggest allies of retirement savers. If you could start in your teens or earlier, think of all the time your money would have to grow. As long as you've got earned income, it's possible with a Roth IRA.

minute: read this article at a glance.

Like many working Americans, Peter Gustafson finds it tough to scrape together enough money to set aside in his retirement account.

Although, unlike most Americans, it's probably not all that important if he misses contributing for a year. At nine years old, he qualifies as one of the youngest working stiffs to start saving for his golden years.

At the suggestion of his parents, Peter wants to put the money he earns cutting four neighbors' lawns into a Roth IRA. Peter's parents think it is wise to teach him not only the ins and outs of running his own business, but also the options available for dealing with the money he earns. Plus, by starting early with a modest contribution, Peter will be able to build a healthy nest egg by retirement.

As long as he has earned income, Peter can contribute it to a Roth IRA. But, since Peter is a minor, there are a few rules his parents need to follow to avoid running afoul of the IRS.

Peter's Plans

Peter's parents, Kevin Gustafson and Betsy Lidecker, aren't Type-A personalities pushing him to be a superkid. Betsy, a mortgage broker, and Kevin, a security system rep, are just two, well-grounded parents trying to pass on good money habits to their only child. They're hoping a Roth IRA will be a good tool for this.

"My own realization that I got started much later than I should have, to put money aside for retirement, has been a motivating force to get my son started now," Kevin said.

And, don't get the idea that Peter's a budding Michael Milken. Like any nine-year-old boy, his main passions are model airplanes, baseball, and video games. One of his goals for the summer is to become the pitcher for his Little League team.

But, Peter also likes to work. Last year, when he earned $320 from his lawn business, Peter learned two lessons. The first was it costs money to run a business. When his mower broke last year, he chipped in half the cost of a $40 repair.

The second was the value of saving. "Last year when he made his money, we let him spend some and (made him) save some," Leidecker said.

Financial planners applaud Kevin and Betsy's strategy.

"If you incorporate matching with a child, it gives them an incentive to save." —Carrie Coghill, certified financial planner and senior vice president of D.B. Root & Co.

"I think (this savings strategy) teaches a lot of valuable lessons," said Robert Weagley, a certified financial planner and associate professor of consumer and family economics at the University of Missouri. Peter will learn the financial golden rule that "we don't reach the goals we have unless we do without," Weagley added.

Admittedly, retirement planning is a very esoteric concept for a nine-year old, but Peter is starting to grasp the concepts of saving and delayed gratification. Last year, at the end of the summer, he had amassed enough money to buy some of the more expensive Pokemon trading cards through an online auction.

And this year? "I want a Sega Dreamcast," he shyly replied.

Matching Contributions

Peter's parents are trying to gently nudge him to boost the amount he saves this summer compared with last summer, when he put away $175.

They realize they are walking a fine line between teaching a fun lesson and creating a situation where Peter resents them for making him put all his money away in savings. So, they've devised a strategy to make it more palatable to give up all his money to a Roth IRA — matching contributions. For every dollar Peter saves, they plan to provide a matching contribution for him to do with as he wants. But, they're not just emptying their wallets. "We would match up to a certain percentage," Leidecker said.

That's a great strategy, said Carrie Coghill, certified financial planner and senior vice president of D.B. Root & Co., of Pittsburgh. "If you incorporate matching with a child, it gives them an incentive to save," she said.

Peter currently cuts four lawns, one worth $10 a cut, two worth $7, and one worth $3. If he cuts each lawn every week, in another 18 weeks he'll earn $486. Add that to the $120 he's made this year, and he could end up with $606 to potentially save.

Tax Implications

According to IRS tax rules for children and dependents, Peter would have to file a tax return if his only income consists of earned income of $4,300 or more. If he only has unearned income, such as from interest or dividends, the filing threshold falls to $700.

Since Peter has a few shares of McDonalds Corp. stock, which does pay dividends, he likely will have earned and unearned income and need to use an IRS worksheet to figure out if he will need to file. He probably won't owe any personal income tax, though.

For more on the tax rules for children and dependents read Publication 929 at the IRS website.

Filing a tax return could actually be helpful, because it will enable Peter to prove he has earned income, which is a requirement for opening a Roth IRA, said William Stecker, certified financial planner and owner of the Marble Group, Ltd. of Divide, Colo.

The maximum a person can contribute to a traditional or Roth IRA each year is $2,000 or the amount of his or her earned income for that year, whichever is less. So if you earn $600, for example, that's all you can contribute.

Even if Peter doesn't have to file a tax return, he can still open a Roth IRA and contribute up to the amount of his earned income, said Coghill. "You aren't required to file a tax return just because you are making a contribution," she added.

However, it's a good idea to keep records of where the money came from and for what services, in case the IRS comes calling.

The Income Has to Be Earned

Peter's lawn cutting business is a two-person show. Kevin admits, "I'm his salesman."

But, Peter provides the brawn, pushing the lawn mower over his neighbors' yards.

That's the most important point in making this saving strategy succeed. The only way the government will allow Peter to open a Roth IRA is if he earns the money he contributes. In other words, Peter has to do work to get the money.

Dividends, interest income, and allowances don't count as earned income and therefore can't be contributed to a Roth IRA. For that reason, in case there's an IRS audit, it's important that Peter keep records of what he earned, when he earned it, and for what job, Coghill said.

The IRS keeps its eyes open for wealthy parents who try to use their kids as tax shelters. If you try to funnel thousands of dollars into a child's IRA so you can get a tax break, when the child didn't earn that much money, the IRS is watching for you, Stecker said.

The maximum a person can contribute to a traditional or Roth IRA each year is $2,000 or the amount of his or her earned income for that year, whichever is less.

Peter won't be able to open a Roth IRA without his parents' help. They'll need to sign the account applications as his guardians. At this point, Kevin is looking to invest the money in a mutual fund, on Peter's behalf.

The one concern that planners voiced is what happens when Peter reaches the age of majority, at 18. At that point, he will have full access to the money to do with as he wants. Coghill said she would encourage him to hold on to the money as long as possible.

Since Roth IRA contributions are made with after-tax money, you can withdraw them at any time without paying a penalty, once you've had the account for at least five years. Interest earned on the contributions, however, are subject to an early withdrawal penalty if pulled out prior to age 59½.

The Payoff Years

What Peter and his parents are trying to do by opening a Roth IRA at this early age is to take advantage of interest compounding. Admittedly, Peter may have some hefty expenses to cover long before retirement — college, cars, or a first-home purchase. But, if he can set the money aside and not touch it, this small investment now could pay huge dividends down the road.

Suppose Peter opened his Roth IRA this year with a $600 contribution and never contributed another dime. At age 65, assuming a 10% rate of return, he would have about $125,000.

But, if he continued to add to his account, at a rate of $600 a year, assuming the same 10% rate of return, his final balance at age 65 would be about $1.37 million.

Stecker questions whether Leidecker and Gustafson are doing the right thing. What about college? "It's not smart to open a Roth IRA unless there's a uniform gift to minors account (UGMA) in place for college expenses," Stecker said.

A UGMA is a mechanism created through the tax code that allows an individual to make a gift of $10,000 or less during a single year to another person to use as he or she wants. It's a way to reduce the taxable estate. However, many states require such gifts to be placed in a trust or a custodial account to be managed by a guardian. If you're interested in UGMAs, consult with a financial planner for additional details.

Gustafson and Leidecker have Peter's college expenses partially covered. To date, they have $25,000 in a savings account just for that purpose.

Check back with 401Kafé.com in October to see if Peter managed to raise his money and open his account ...

The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.