Rules and Regulations for Investing with Kids
Tax Rules
The first concerns that you have probably have to deal with the IRS and taxes. Investment income earned by your child will be taxed differently based on the amount that is earned. If the child is under the age of 14 and earns less than $800 from investment activity, then you don’t have to file a tax return for them. However, if they earn over $800 in investment income you will have to file a separate income tax return for your child. For investment income between $800 and $1,399 the income will be taxed at a reduced child tax rate. However, once the amount exceeds $1,400, the income is taxed at the adult rate, which can be as high as 35%. This tax rate will depend on the amount of money earned through the investment activity, as well as how much the child’s parents earned. If your child earns over $1,400 in investment income then they will need to fill out and file IRS Form 8615. This form can also be filled out to determine weather their investment income should be claimed on your income tax return, or on your child’s income tax return. If you, or your tax professional, decide to report the investment income on your tax return and the child’s other income is less than $750, then you will need to fill out and file form 8814 with your federal income tax return, and your child won’t need to file a tax return or a form 8815. It is recommended that you run your tax return both ways to see which one generates the best tax liability scenario.
Investment Option For Kids Number One: ROTH IRA
One of the simplest and safest investment activity that a child can take advantage of is a ROTH IRA. A ROTH IRA is a retirement savings account that can be used to purchase a first home without penalties. The money is taxed before it is deposited, and it is not taxed when the person withdraws money from the account upon retirement. The advantages for children who open a ROTH IRA account is that they probably won’t have to pay taxes on the money that they earn, and they also won’t have to pay taxes when they withdraw the money upon retirement. This double win situation, as well as special circumstances that money can be withdrawn pre-retirement without penalties, makes this investment option ideal for kids. However, there are a few rules and regulations that need to be taken into consideration.
First, there is no age minimum to set up a ROTH IRA so you don’t have to wait to set one of these accounts up for your child. Secondly, the type of income that can be deposited has to be classified as “earned income.” This means that allowances or money for chores do not qualify as earned income. However, money earned through formalized business arrangements can be classified as earned income even if the child doesn’t receive a W-2. For example, babysitting, pet sitting, mowing lawns, and working at a family business all count as earned income for the purposes of qualified deposits into the child’s ROTH IRA. In addition to having a limitation as to what types of income can be deposited, there is also a maximum amount of money that can be deposited in a single year, and that amount is the same as it is for adults with ROTH’s, $4,000. (Note this amount was current for the 2005 tax year, consult the IRS website for up-to-date limitation amounts.) If you want to help establish your child’s ROTH IRA, or if a family member wants to help, gifts can be made up to the amount of the child’s income or a maximum amount of $4,000.
IRS
http://www.irs.gov
Investment Option for Kids Number Two: Playing the Stock Market
Buying stocks is another great way kids can experiment with financial planning, strategy development, and financial analysis. The only limitations for kids buying stocks are the same as those placed on adults. They are limited to the amount of money they have to spend, and they must pay taxes on the money that they earn. (See Tax section above). Besides these limitations, your child can invest their little hearts out. For very young children I would recommend that they invest through you, or that you supervise and guide the investments that they make. As the child gets older you can set up a separate investment account for them with your broker, or through an online brokerage firm that offers children’s stock programs.
Make investing a family activity. You can start out by identifying companies that produce products that the family uses, or that the child and their friends use. For example Disney, Dreamworks Animation, Pepsi, Coco-cola, Crayola, etc. Then use a stock-monitoring site like Yahoo! Finance, to analyze how each of these companies’ stock is doing and select one or two to invest in. Teach your child how to chart, or print out the stock’s activity, and teach them how to determine when a stock should be sold, and when it should be acquired. If you are unfamiliar with investing, check out books from your local library and learn together as a family.
Investment Option for Kids Number Three: Savings Bonds and Money Market Accounts
If you don’t want your child to risk their investment money, then you can set up a money market account, or buy savings bonds for them. Money markets have the advantages of higher interest rates than generally savings accounts do, and they still allow money to be withdrawn when the child needs money without penalties. To find the financial institute with the best rates and programs for kids you will need to do some shopping around. Ask about children’s savings programs, and matching programs for college savings accounts. Interest earned in a money market account is only taxable if your child’s income is greater than $750. If their income is less than this amount you don’t have to worry about filing a tax return for your child.
Savings bonds are another great investment option that you can get the whole family involved in. Savings bonds are generally purchased at half the price of their redemption value. While doubling your investment by a specified date seems lucrative, it generally takes 20 years for bonds to mature. However, if you can get your child’s grandparents, aunts, uncles, and other family and friends to routinely give savings bonds instead of traditional gifts, the amount of money that the child will be able to redeem when they are in college or starting out on their own will be a healthy sum. Taxes on interest earned will be calculated upon redemption and may be influenced by new tax laws and special circumstances. For more information about tax liability on savings bonds please visit the IRS’s website.
Conclusion
Allowing your child or children to invest their money will not only teach them valuable financial management skills, it will also provide them with a more financially secure future. With proper guidance and encouragement, they may be able to earn enough money to pay for their college education, buy a new home, or provide for their living expenses once they leave the nest. Make investing a family activity, it will not only help to bring you together as a family, but it will also help to improve your family’s financial future.
