Can I Invest in an IRA for My Child if I Make Too Much Money?

by Wilhelm Schnotz

Retirement planners will tell you it’s never too early to start planning for retirement -- even for school-age children. If you make regular contributions to your child’s traditional individual retirement account or Roth IRA because of retirement plan income limits, your child’s nest egg has decades to grow before maturity, compounding gains over a long period. This makes retirement accounts for children a powerful retirement tool. Although putting money into an IRA for your child is a way to sidestep some income limits on qualifying contributions, you’ll need to make sure your child qualifies to contribute to an IRA before you open one for him.

Income Limits and IRA Contributions

In general, the Internal Revenue Service doesn’t limit who can make IRA contributions based on their adjusted gross income. As of 2011 investors could place up to $5,000 or their gross income for the year, whichever is smaller, into an IRA. The limit is $6,000 for those 50 or older. If your employer offers a 401k or a similar plan, your ability to deduct IRA contributions might be curtailed if you earn more than $56,000 ($89,000 for a married couple). If you’re enrolled in an employer-sponsored retirement plan and your adjusted gross income exceeds $66,000 -- $109,000 for a married couple -- you can’t deduct your IRA contribution.

Children and Traditional IRAs

The IRS requires a taxpayer to report taxable income before making contributions to an IRA, which might limit your ability to make contributions in your child’s name to her IRA. Younger children who aren’t employed don’t qualify for IRA contributions, so you’ll need to wait until your children are old enough for a part-time job before you open an IRA in their names. Even then, you may contribute no more than the child’s annual reported earnings. So if your child spends a summer busing tables and earns $2,100 as reported on her W-2, tax law effectively caps your contributions to her IRA at $2,100, not $5,000.

Deductions for Children's IRAs

If your child receives earned income, the IRS allows you to make contributions to his IRA in his name, but you can't claim the contribution as a deduction. Instead, your child is allowed to claim the deduction as if he made it himself. The above-the-line deduction reduces his adjusted gross income on a dollar-for-dollar basis. Although adult children who work full-time might receive a tax break from your contributions, there might be no tax advantage for younger children who don’t earn enough to need to file tax returns. Dependents aren’t required to file until they receive $5,700 in earned income, $950 in unearned income.

Roth IRAs and Children

Rather than make a contribution to children’s traditional IRAs, many parents instead make contributions to a child’s Roth IRA. Children with low earnings receive no immediate tax advantage for their contributions -- the deductions are wasted if they don’t file income taxes -- and with a traditional IRA, they’d eventually pay income tax on distributions. With post-tax contributions to Roth IRAs, you’ll pay income taxes now, and not qualify for the deductions that would have a negligible impact on your child’s tax situation. When she receives a distribution from a Roth IRA, she’ll won't have to pay tax on it. The requirements to contribute to a Roth IRA are the same as those for a traditional IRA: Your child must be employed, and you can’t contribute more than $5,000 or the amount of her annual income.

About the Author

Wilhelm Schnotz has worked as a freelance writer since 1998, covering arts and entertainment, culture and financial stories for a variety of consumer publications. His work has appeared in dozens of print titles, including "TV Guide" and "The Dallas Observer." Schnotz holds a Bachelor of Arts in journalism from Colorado State University.

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