Pay Your Kids, Help Yourself by Allen I. Kutchins As parents, there are a thousand things we want to do for our chil­dren, but few of us consider the possibility of saving for our chil­dren's retirement. Yet starting a child on the road to long‑term finan­cial security can be a great gift and one that is well within the reach of most parents who operate their own businesses. To do this, you will need some cooperation from your child because he or she actually must perform some useful work to get the process moving. If you can sur­mount that hurdle, you can reduce your own tax burden and let the child benefit from the amazing power of compound interest to turn a modest annual savings into an impressive accumulation of assets.

Here's an example of how it works.

Let's say that for eight consecutive years you pay your child $4,800 annually and put $3,000 of that amount into a Roth IRA in the child's name. If that IRA earns 6 per­cent simple interest and your last contribution is made when the child is 18, the account value would grow to S346,000 bv the time the child is 60 years old.

If the interest rate earned over the He of the account were 8 percent, the total would be $819,000. Should you be able to lock in a 10 percent return, your offspring would have a sumptuous $1‑.9 million cushion for retirement. All of this on a $24,000 investment!

A Roth IRA contribution is not tax deductible, but keep in mind that before being subject to federal income taxes for 2001, a dependent child can earn up to $4,800 a year (the standard individual deduc­tion of $4,550 plus $250). At the same time, you can deduct all those wages as business expenses, thus lowering your pre‑tax corporate profits or (if a sole proprietor) your own annual earnings.

If you pay your child more than $4,800 a year, you still are likely to come out ahead because your child almost certainly will pay income taxes at a lower percentage rate than you or your corporation do.

A Roth IRA also offers other benefits to your child. The child can withdraw, tax‑free and at any time, the amount of the contri­butions previously made to the IRA (because the taxes already have been paid on that money). Also, there is no requirement, as there is with other types of IRAs, that the beneficiary of a Roth IRA must begin taking distributions once reaching the age of 70 years.

Sounds good, right? What makes it even better is that get­ting there isn't particularly dif­ficult or complicated. Here's what you have to do:

1. Hire your child to do some meaningful work suitable to his or her skills, such as filing, light typ­ing, emptying garbage, packing boxes, or stocking shelves. Then pay the child a wage appropriate for such work. If the compensation paid is unreason­ably high for the work done, it may be viewed as a disguised gift, and the business deduction will be disallowed. If you pay less than a reasonable wage, you'll have to deal with your own conscience.

2. The child must have some control over the income he or she earns, but the Roth IRA contribution qualifies for that purpose. If the parent retains control over the child's entire income, the parent may be required to include those earnings in his or her own income.

3. If your business is a sole proprietorship (or if it is a partnership and all the partners are family members), you will not have to make Social Security contributions for a child under age 18 or pay Federal Unemployment (FUTA) taxes for a child under age 21. However, these tax exemptions are not available to corporations.

4. Money earned by the child but not contributed to the IRA may be used in various ways. The child can retain it as pocket money. It can provide addi­tional savings for the child even though the earnings on those savings will be taxable, or it can be used for a purpose that benefits the child, such as tuition or medical care.

Additionally, by shifting earnings to one child or several, you will reduce your own earnings and, ulti­mately, your own tax liabilities. The extent to which your taxes are reduced will vary on a case‑by‑case basis, but let's look at one example:

Suppose you operate a sole proprietorship and hire your two children to work for it, paying each of them $4,800 a year ($400 per month). The result will be a $9,600 per year reduction in your business earnings.

Assuming you are in the 32 percent tax bracket, that would reduce your annual income tax burden by $3,072 and your self‑employment tax by $1,409 if you have not already reached the annual maximum. At the same time, you will incur no additional federal employ­ment tax liabilities (though your state tax liabilities might rise slightly). Meanwhile, your two children will not have to pay federal income tax on their earnings and will be well on their way to a comfort­able retirement.

This strategy is especially attractive for several other reasons. It familiarizes your children with your business, which they one day may control. It involves them in helping their family achieve its col­lective financial goals, and it introduces them to the incentives of employment in a meaningful way. It's a win, win plan.