In addition to classwork, many high school and college students work at least part of the year. The Bureau of Labor Statistics estimates that approximately 18 percent of high school students were employed in 2015, while 45 percent of college students held either full or part-time jobs. Because they have earned income, these students are eligible for an important, but widely overlooked, tax-advantaged savings opportunity called a Roth IRA. Parents (or grandparents, or really anybody) in the know can help children set up and fund a Roth IRA, helping to put them on a path to financial independence.
The purpose of this post is to explain why a Roth IRA should be on the minds of parents and grandparents and the steps they need to take before Tax Day.
What is a Roth IRA? This important savings vehicle was established by the Taxpayer Relief Act of 1997 and was named for its chief legislative sponsor, Senator William Roth of Delaware. A Roth IRA is a retirement savings account that allows money contributed into it to grow tax-free. Someone funds a Roth IRA with after-tax dollars, meaning they have already paid taxes on the money they put into it. In return for no up-front tax break, their money grows tax free, and when they withdraw the money at retirement, they pay no income taxes on the investment gains.
How does this apply to high school and college students with earned income? There is no minimum age limitation on Roth IRA account holders, so students can have one. Moreover, they can also be claimed as a dependent on their parent’s tax return and still be eligible to open and receive contributions to a Roth IRA.
How much can they contribute? The contribution limit is the lower of $5,500 (for 2016 and 2017 tax years) or the amount of earned income the child made in that calendar year.
How can relatives help them fund the account? Parents can incentivize kids to contribute to a Roth IRA by matching contributions. For example, if Junior made $2,000 last summer filing papers in an office, mom and dad, the grandparents, or someone else, can say to Junior that if he contributes $500 to his Roth IRA, they will fill the account up with the remaining $1,500 of allowed contributions. If the parent, another relative, or friend is self-employed, they can also be the one to hire the student and pay them. This qualifies as earned income for Roth IRA contribution purposes. The hourly rate must be reasonable, or the IRS may disallow the contribution.
Any tips for convincing students to put money into a Roth IRA? Retirement planning is rarely an issue on young peoples’ radars. Suggesting they put away money for it often leads to blank stares. However, Roth IRA contributions (but not investment earnings in the account), can be withdrawn for any reason, at any time, without any tax or penalty. This should make young people much less reluctant to contribute. They can use Roth IRA as the vehicle to save for other goals, such as a down payment on a home.
Is it still possible to contribute to a Roth IRA for the 2016 tax year? Yes. Roth IRA contributions can be made by the tax filing deadline (without extensions) for the tax year in which the contribution will apply. The 2016 tax year filing deadline is April 18, 2017, a few days later than usual
What if the 2016 tax return has already been filed? Contributions can be made even if the student’s 2016 tax return was already filed. Because Roth contributions are not tax-deductible, they do not impact the income tax calculations and do not need to be reported to the Government. That being said, it is important to keep records of tax years and contribution amounts for the eventual time when withdrawals will be made.
Disclaimer: Get advice from your tax professional before making any tax-related moves. Minerva Wealth Advisory does not provide tax advice.
DISCLAIMER: This information is not intended to provide legal or accounting advice, or to address specific situations. Please consult with your legal or tax advisor to supplement and verify what you learn here. This is presented for informational or educational purposes only and does not constitute a recommendation to buy/sell any security investment or other product, nor is this an offer or a solicitation of an offer to buy/sell any security investment or other product. Any opinion or estimate constitutes that of the writer only, and is subject to change without notice. The above may contain information obtained from sources believed to be reliable. No guarantees are made about the accuracy or completeness of information provided. Past performance is no guarantee of future results.
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