If you are a business owner and have children, you might not be taking advantage of a simple strategy that can save you taxes, while also getting a jump start on your kid’s retirement savings.
Through your company, you can hire your child as an employee and pay them a reasonable wage for the work they perform for the business. This one action is beneficial in multiple ways, which include:
- The wages you pay your kid is deductible by the business. Thus, you are lowering your income from the business which, in turn, lowers your taxable income.
- Any person that earns W-2 wages is eligible to open and contribute to a Roth IRA in their name. The main benefit of a Roth IRA is that it grows tax-free and any distributions you take from this type of account are also tax-free. Keep in mind that their contribution amount is limited to the lesser of their W-2 income or the annual contribution limit ($6,000 for 2022; $6,500 for 2023).
If you were to pay your kid up to the yearly standard deduction ($12,950 for 2022; $13,850 for 2023), your child would not be subject to Federal income taxes. Thus, they would be able to contribute money into their own Roth IRA tax-free, the money would grow tax-free, and they would be able to take distributions from this account tax-free.
The below picture shows the impact that early investing can make over the course of a person’s lifetime.
Additionally, this article does a great job at
explaining the benefits and tax implications of this strategy, as well as giving you a step-by-step guide for how to go about implementing it.