Talking taxes: Summer employment and Roth IRA contributions for children

Parents and grandparents can contribute to a Roth IRA for their children or grandchildren up to $6,500 for 2023, but the child must have earned income, and the amount contributed cannot be more than the child’s 2023 earnings.

The 2023 IRA contribution deadline is April 15, 2024. There are several benefits to the Roth under current rules:

• Earnings grow tax-free inside the Roth IRA. Over 40 or 50 years, compound growth could turn into a tidy sum.
• Contributions can be pulled out tax-free at any time.
• Distributions of earnings are only tax free after 59 1/2 if the Roth IRA has also be held for 5 years.
• $10,000 in earnings can be taken out tax-free to buy a first house but must be used for a down payment or closing costs.

Why a Roth instead of a deductible IRA contribution?

Summer employment tends to be on the low side of earnings, which means the child’s tax bracket is likely to be low as well. Consequently, an IRA contribution deduction can be far from meaningful.

Note: The Roth contribution from a parent or grandparent to the minor’s account will count toward the annual gift exclusion ($17,000 per recipient, $34,000 if married).

Disclosures

Information provided by Independent Advisor Solutions by SEI, a strategic business unit of SEI Investments Company (SEI).

The examples used are for illustrative purposes only.

This information should not be relied upon by the reader as research, legal, tax or investment advice. This information is for educational purposes only, is current as of May 18, 2023, and is subject to change.

Neither SEI nor its affiliates provide tax advice. Please note that (i) any discussion of U.S. tax matters contained in this communication cannot be used by you for the purpose of avoiding tax penalties; (ii) this communication was written to support the promotion or marketing of the matters addressed herein: and (iii) you should seek advice based on your particular circumstances from an independent tax advisor.

Investing involves risk, including possible loss of principal.

The IRA is opened in the child’s name, and the child receives any tax deduction for the contributions. If the child is a minor, the account will be a custodial or guardian account. As the custodian, the adult control the assets in the IRA, making all investment decisions, until the child reaches majority age, at which point the account is turned over to them.

Earned income includes money made from employment including wages, salaries, bonuses, commissions, tips, and net earnings from self-employment, according to the IRS definition. An allowance or investing income is not considered earned income.