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May 11, 2011

IRAs for your children

One of the benefits of IRA accounts is the deferral of tax on income and gains in the IRA or other qualified retirement account.  The longer funds are in an IRA the longer the funds can compound tax-free. 

The earlier your children are when they start contributing to their own IRA the better off they will be.  It will help them learn good saving habits that will benefit them throughout their lives.  Alternatively, you can make the contribution for them.  This is permissible even if they spent or saved the income they earned.    

Your children must have earned income to qualify to contribute to an IRA.  Income earned from a part-time or seasonal job qualifies as earned income.  Gifts and allowances are not earned income 

You can pay them a reasonable amount for the services they actually provide in your business, if you are self-employed.  The amount paid will be taxed, if at all, at a lower income tax bracket if you are in a higher income tax bracket than your child.

Your child can contribute in 2011 the lesser of the amount of earned income or $5,000.  If they earned more income they should consider a SEP.  Then they could contribute the lesser of 25% of their earned income or $49,000.   

If you child is a minor check with your financial institution for the procedures required to open an account for a minor.  A parent or legal guardian will need to sign the application.

A Roth IRA should be considered.  Any income earned within the IRA can be withdrawn from the account without tax or penalty if the money is used for certain expenditures such as college or the purchase of a first home.  Distribution will not be taxable if the account has existed for at least 5 years and after age 591/2.

Please check with your advisor for limitations and other special rules that may apply to you or your child,     

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