Tax Tip of the Week
For the week of June 28, 2004

Should your child have an IRA?

Is your child planning to work at a summer job this year? If so, why not encourage him or her to set up an IRA? Oh sure — what teenager wants to put his summer earnings in a retirement account! But that need not be a problem. If you’re willing to provide the cash, your child can establish an IRA and get a head start on tax-favored retirement savings. Here’s how it works.

Generally, anyone can open an IRA if they have taxable compensation from wages or self-employment earnings. This year, the contribution limit is $3,000 or the amount of compensation, whichever is less. Let’s say your daughter, Sally, earns $5,000 at a summer job. You could give her up to $3,000 which she can use to open an IRA account in her own name. She’ll have $3,000 in a tax-sheltered account which can compound for years until she uses it in retirement. And she’s happy because she still has her take-home pay to spend.

Regular or Roth? In most cases, she’ll have the choice of opening a regular IRA or a Roth IRA. With a regular IRA she’ll generally receive an upfront tax deduction, but her withdrawals in retirement will be taxable. Chances are she’s in a low tax bracket, so the tax deduction may not be worth much. In this case, a Roth IRA may be the better choice. She’ll forego a tax deduction, but her withdrawals will be tax-free when she retires.

By starting early, the IRA funds will have years to compound tax-free, and you’ll be instilling a good example of saving. Later in life, Sally can even access the funds penalty-free for certain pre-retirement hardship withdrawals, such as medical or home-buying expenses.

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