Think of it as the rite of the American transition. It’s the classic paper route, lemonade stand, babysitting and lawn mowing of the neighbors. Any of these “chores” can make a child enough money to do fun things … and more.
It is in this “and more” part that things get difficult. Perhaps the most lucrative benefit to children working alone is that they are now eligible to contribute to a children’s IRA.
Child IRAs are like regular IRAs. The difference is that underage children cannot set up IRAs on their own. “Usually the parent or adult creates the account with the child,” said Jill Gleba, founder and president of Gleba & Associates in Troy, Michigan. “It’s the child’s money and account, but since they are minors, parents have to sign the papers too.”
That’s not all of the paperwork that needs to be filled out. While the parents don’t have to fill out this other paperwork, it’s probably a good idea for them to oversee it.
But first, what counts as earned income? This is important as not all of the “incomes” your child receives are considered “earned”. For example, gifts are not earned, they are, well, they are gifts.
Okay, this may be a little obvious, but there are less obvious “transactions” that do not fit the definition of earned income.
“For a child (or anyone else) to qualify for an IRA grant, the individual must meet the IRS definition of earned income,” said Charles H. Thomas III, founder and president of Intrepid Eagle Finance in Clover, South Carolina. “Self-employment can qualify, but it has to meet the IRS rules. Something like housework allowance doesn’t qualify. “
In principle, any type of work that your child is paid for brings an income from work. Sometimes this produces a 1099 or a W-2, sometimes it doesn’t.
“As long as a child has earned an income, they can contribute to a Child IRA,” said Dominic Trupiano, VP of Sales & Marketing at Artesys (RT Jones Capital Equities Management, Inc.), based in St. Louis. “For jobs that don’t have a 1099 or W-2, it’s important to keep a record of the type of work, when and where it was done, who paid for the work and how much.”
It is this latter type of job that doesn’t spawn 1099s or W-2 forms that is often a child’s first job. Examples could be doing gardening for neighbors, watching the children of a family friend, or helping a local organization with temporary work. If you want to use this income as a basis for contributing to a child IRA, you will need proof that it is really earned income.
The simplest proof is what you are already telling the government. That will tell you how much you can add to your IRA.
“If the child or teenager has earned more than $ 400 in income, they must file the income on a Form C on their tax return,” said Mike Branson, CEO of All Reverse Mortgage in Orange, California. “As long as they don’t deposit more than $ 6,000 in a single tax year, the child or teenager can use their income for their Child IRA.”
In addition to the tax form, you need to keep an organized book of the activities that generated the labor income. Not only will this help you file your taxes, but it will also serve as proper evidence that you have earned that income.
“Since kids or teens typically don’t get a W-2 for babysitting or mowing the lawn, it’s up to the child (or their parents on their behalf) to keep good records or a log of their work,” says Tiffany Lam-Balfour, Specialist for investing and retirement planning at NerdWallet in San Francisco. “This is important because a child must have an income to contribute to an IRA, and that contribution cannot exceed what they have earned (or the annual limit of $ 6,000 for 2021).”
How can parents help? Well, you could actually keep the records for the child. But does this really teach the child what a parent wants to teach? No. It is better if the parents show what to do first and then guide the child to keep the records on their own.
“If the job doesn’t produce a paycheck, ask your child to keep an income table or write in a simple notebook,” said Christie Whitney, VP of Investment Advice and Director of Planning Rebalance, Palo Alto, California. “Chances are they don’t have business overheads, so keep it simple: date, customer, service, and amount earned.”
So, yes, money on babysitting and mowing the lawn can go into a kid’s IRA. However, it is important that you have reliably recorded these sources of income.
A children’s IRA can be a wonderful tool to help your children learn the important everyday aspects of finance. You don’t want this to be the reason your child experiences the awful reality of an IRS audit too.