Using Summer Jobs to Create Roth IRAs as Estate Planning Start

More American teenagers than in recent years are seeking summer jobs this year (though fewer than in the old days). You can help make a summer job more profitable for your grandchildren and teach them about long-term Estate Planning at the same time. Or you can provide an additional incentive for the teenager who doesn’t have enough motivation to seek summer employment. You do all this while creating a long-term legacy and helping provide for the grandchild’s future financial security.

All this is accomplished when grandparents (or parents) help convert summer job income into Roth IRA contributions.

Contributions to IRAs (both traditional and roth iras) are limited to the lesser of $5,000 and the IRA owner’s earned income for the year. (The $5,000 limit is indexed for inflation.) Earned income is non-investment income, such as wages and earnings from self-employment. Teenagers generally consider the long-term to be next week, so they aren’t too concerned about funding retirement and won’t think about Roth IRAs on their own. They also don’t want to take a portion of their meager summer earnings and lock it up for a few decades.

Here’s where you come in. You can contribute to a Roth IRA for your grandchild.

To create an estate planning incentive for the youngster, you can say you’ll match in Roth IRA contributions the grandchild’s earnings dollar for dollar or at some other ratio, up to the IRA contribution limit or some lower amount. This lets the grandchild know it’s an “earned gift” that increases as his earnings increase. Plus, you’re protected by a ceiling on your contributions.

The arrangement also can be an opportunity to teach the grandchild about long-term estate planning, retirement, compound earnings, and other important matters. You can show the grandchild how the Roth IRA will grow to a much greater amount when the grandchild is age 65. After the grandchild sees payroll taxes and perhaps other taxes deducted from the first paycheck, you can explain that the Roth IRA distributions are tax free under current law, so the grandchild will benefit from the full amount when distributions are taken from the Roth IRA.

Over decades, the compounded returns can be impressive. Suppose you contribute $5,000 this year and the IRA earns 5% annually. In 40 years, the IRA will be worth $36,960, and in 50 years it will be worth $60,204. At an 8% return, in 40 years the IRA’s balance would be $117,312, and in 50 years $253,269.

The IRA contribution counts as part of your annual gift tax exclusion, which in 2010 is $13,000 per person. You can give any person up to $13,000 during free of gift taxes. Spouses have an exclusion of $26,000 on gifts made jointly.  (The gift tax still is in place, though the estate tax expired Jan. 1, 2010.) You can make a gift to your grandchild to fund a Roth IRA.

Helping a grandchild set up his or her first Roth IRA is a great way to establish a legacy and teach some sound financial principles. It’s also a practice that can be carried through the whole year for youngsters who need to work during the school year.

July 2010. RW