First off, review this list of answers and accept how incredible this idea is, to both fund college, make your kids earn it, and do it all in a tax-advantaged way:

• Yes, income earned in the home can be put into a child’s Roth (within the rules)
• Yes, the income and savings can be used for college, or really any major life purchase
• Yes, it is a relatively easy strategy if you follow the below tips

If you are raising your kids like I am mine, the early years are an important time to ingrain a set of good money habits that hopefully they keep for the rest of their lives. I require my kids to put 10% of any money they earn into the following categories, college, giving, and taxes (back to the family). Meaning they only ever get to spend about 70% of their income. This has been met with several comments ranging from “awesome” to “cruel”. But for my kids, it’s all they know. They don’t negotiate or object to taxes because it has always been how they get paid. I hand them a dollar and take a dime back instantly. It’s visceral, and habitual at this point. 

I feel money is a difficult idea if children are never given the opportunity to handle it, hold it, and lose it. When it comes to teaching financial lessons, setting a good parental example is important, but actually giving the child some experience making wise financial decisions is essential. This includes both giving the child decision-making authority with their own money and giving the child the means to earn money outside of or instead of an allowance.

This is where the Roth comes into play, and your opportunity to hire your child…

This is an open platform to pay your children in a way that makes sense for your family. And the best part is that this payment can be counted as earned income and thus qualifying for Roth eligibility. But there are some rules you need to follow and this article will walk parents through the right way to keep the Roth eligibility intact. 

You will want to make it clear, under which IRS designation you want to use. The two options are as a self-employed independent contractor or a household employee of yourselves. 

This all might sound silly, hiring your child as a contractor, but the benefits make it worth it. I promise. And like taxing your children, it might only sound silly because it’s new, but your kids won’t know this isn’t normal and will just roll with it.

The Independent Contractor Route…

If you decide that your child is an independent contractor, then all of the child’s earnings must be reported as Self-Employed on Schedule C. 

So it should be noted that if their net earnings from this kind of self-employment are more than $400, the child would need to pay self-employment tax (Medicare and Social Security) on Schedule SE. That’s an important threshold to be aware of. 

Quite possibly the best part of choosing the independent contractor route is that your child could work for many different families. So if they are routinely engaging in neighborhood childcare, lawn maintenance, or other jobs in your community, this might be the most open path. 

Let’s be clear though, this route still requires that the child follow the child labor laws. But these laws are reasonable restrictions for most circumstances. 

The first law of note is the age restrictions on certain occupations. If your child is under 14, then the list of potential occupations is limited to:

• delivering newspapers to customers;
• babysitting on a casual basis;
• work as an actor or performer in movies, TV, radio, or theater;
• work as a homeworker gathering evergreens and making evergreen wreaths; and
• work for a business owned entirely by your parents as long as it is not in mining, manufacturing, or any of the 17 hazardous occupations. This is the sweet spot for any family that has 1or more family businesses. 

At age 14 and above the universe of employment can expand to include:

• intellectual or creative work such as computer programming, teaching, tutoring, singing, acting, or playing an instrument;
• retail occupations;
• errands or delivery work by foot, bicycle, and public transportation;
• clean-up and yard work which does not include using power-driven mowers, cutters, trimmers, edgers, or similar equipment;
• work in connection with cars and trucks such as dispensing gasoline or oil and washing or hand polishing;
• some kitchen and food service work including reheating food, washing dishes, cleaning equipment, and limited cooking;
• cleaning vegetables and fruits, wrapping sealing, and labeling, weighing pricing, and stocking of items when performed in areas separate from a freezer or meat cooler;
• loading or unloading objects for use at a worksite including rakes, hand-held clippers, and shovels;
• 14- and 15-year-olds who meet certain requirements can perform limited tasks in sawmills and woodshops; and
• 15-year-olds who meet certain requirements can perform lifeguard duties at traditional swimming pools and water amusement parks.

At age 16 or 17, almost any job that is not expressly prohibited (like alcohol serves or licensed operations) becomes available to children. 

For more details on the standing labor laws and how they pertain to children consult YouthRules.Gov.

The Household Employee Route…

This is likely the more common route, and requires less diligence in what the job is, and the laws that protect it. There are two general guidelines you still note before you take this route: 

1. Your list of jobs allowed under child labor laws expands significantly as you are allowed to “work for a business owned entirely by your parents as long as it is not in mining, manufacturing, or any of the 17 hazardous occupations” at any age.
2. The wages are exempt from FICA taxes if they are working for a business owned solely by their parent(s).

When determining if this employment is suitable this is the question you need to ask yourself: Does the employer (you) have control over how the work is done? What jobs, where, with which provided tools, and when? If the answer is yes, then the child is an employee and the IRS allows for their employment by you. This route, should apply in most cases, to yard work, cleaning and other household and maintenance chores. 

The IRS provides a list of likely, but not complete, domestic employees. They include Babysitters, Butlers, Caretakers, Cooks, Domestic workers, Drivers, Health aides, House cleaning workers, Housekeepers, Maids, Nannies, Private nurses, and Yard workers. As this list also overlaps with most chores parents want to delegate to their children, there is a strong precedent here for being able to count your children as household employees.

Now take out a pen and paper and write this part down and remember it, this is the best part of selecting this route. The IRS states on the “Family Help” page that “Payments for the services of a child under age 18 who works for his or her parent in a trade or business are not subject to social security and Medicare taxes if the trade or business is a sole proprietorship or a partnership in which each partner is a parent of the child.” 

This is a huge distinction for families looking to pay their child and access the roth, but not make taxes more complicated. This clearly states that wages earned from their parent employer to a child employee are not subject to the FICA taxes of Social Security and Medicare. This is the easiest route to make this work at home. 

Keep Records as a company would…

When it comes to picking what job your child does, my advice is that there should be two lists of chores. We do this in our house, there is a list of choices that my kids need to do regardless. The room and playroom are their responsibility. Then we make a chore list of items we are willing to pay for their service on. Yard work, cleaning the garage, and other weekend projects make up this list. This sets a clear bright line regarding when my kids are “getting paid”. Additionally, we have made it clear that having their personal spaces clean, is their ticket to getting to work on the earned money chores list. 

When setting a price for these chores it’s still up to you, the employer. It is also important to remember that you are replacing the service with someone coming from outside the home. And while you are still in charge, fair compensation helps make this a successful habit in the house. 

If you are looking to establish a benchmark, you might look at minimum wage laws. Even though the minimum wage law does not apply here. The current federal minimum wage is $7.25 per hour so make this your starting point. My kids are 5, so it would be impossible to pay them hourly for the simple tasks I ask of them. But it’s important to note that you can pay by the task. So my kids, if they complete all their chores usually can earn $5-7 dollars. I also give them performance bonuses if they 1) go above and beyond, 2) have a good attitude and 3) complete in a timely manner.

Since you are planning on using an IRS program, the best protection is good records. We have provided a template for my system HERE. And encourage you to follow it each time your child does a job, save and record the work (we even have our kids “chart” their activity to get a sense of saving up the money):

• when and/or for how long the child worked,
• what task they were doing,
• what they were paid,
• when you paid them, and
• how much of their pay was in cash.

Now for the reward…eligible Roth IRA Funding

Once your child has earned the income, then your child is eligible for an amount of Roth IRA funding. It’s as simple as that. If you have your method of employment established, the records for the word they have done, simply deposit cash into the Roth. 

Because Roth is post-tax dollars, deposits can pretty simply be made into the child account. The child can contribute. Parents can contribute. Grandparents can contribute. A random friend can contribute. The only restriction here is the limit on how much you can contribute. These limits are either 1) the earned income amount or 2) this year’s IRA contribution limit whichever is smaller. So if you have records that support your child making +$6k in a year, they are eligible to max out their contributions in that year. In our household, we match their earned income, with contributions made to their Roth as a bonus, and with the belief that this account will fund college a house or be a fantastic headstart on retirement planning. 

This account has the potential then to grow for over 60 years, tax-free.

In the end…

This vehicle is an essential part of long-term planning for retirement and college or any other venture the child needs when they need it. It also incorporates an important lesson about earning money and saving. Using such a fantastic tax-advantaged account as the backbone to a lifetime of saving and mitigating taxes at such a young age is an irreplaceable investment in your child’s future. 

 

Disclosure:

This article is meant for informational purposes only. Formal recommendations from our financial advisors come in the formal, InSight-Full®, P.E.A.K Program®, and InStep® processes and are consented to and agreed to in the client’s Investment Policy Statement. 

Several topics discussed here may not be right for you and your situation. You should consult your CPA or tax advisor to make sure this strategy is congruent with your strategy and work in your circumstances. Work with a CFP to determine that this does not negatively impact the rest of your financial picture.