Proving a Child Has Income for a Roth
My 17-year-old grandson wants to open a Roth IRA with money he has earned mowing the neighbor's grass, shoveling snow, walking the dog, etc. Because he is paid in cash, how can he prove he has legitimately earned the money?
Don't worry. Your grandson doesn't have to have a W-2 to justify opening an IRA. After all, most kids don't get formal documents for doing informal jobs for neighbors. It would be nice -- in the highly unlikely even that the IRS ever asks about this income -- if he had a contemporaneous log of the jobs and how much he made from each one. If he didn't keep such records, suggest that he prepare such a document now. He needs to know how much he made because the IRA contribution can't exceed his earnings (or $4,000, whichever is less). Your grandson can make a Roth contribution even if he's not required to file a tax return for 2006. Roth contributions aren't reported on the return.
He doesn't actually have to contribute his own money; you or his parents can help. The key is that the contribution can't be more than the earned income limit.
The big payoff comes in the future. If your grandson invests $1,000 in a Roth IRA when he's 17, that money will grow to about $47,000 by the time he's 67, if the investments return 8% per year -- which is well below the long-term average return for stocks. That's just from the original $1,000 investment, and the money is tax-free in retirement because it's in a Roth.
If you start your grandson in the saving habit and he continues to contribute $1,000 every year, he will amass more than $600,000 in his Roth by age 67 -- just by contributing about $83 every month.
If he needs money before then, he can withdraw the contributions without a penalty at any time and can withdraw up to $10,000 tax-free and penalty-free for a first home.
He still has until April 16, 2007, to open a Roth IRA based on his 2006 income and can contribute to a 2007 Roth anytime now, too.
For more information about opening a Roth for a child, including a list of fund companies and brokerage firms that will open Roth IRAs for children, see Roth Rules for Kids.
Got a question? Ask Kim at firstname.lastname@example.org.