You may have heard about this nifty tax deduction for the self-employed: getting a Roth retirement account set up for your child and contributing the maximum amount yearly. The sometimes overlooked hiccup with this tactic is that your child has to have EARNED income to contribute to a Roth. And no, an allowance does not constitute earned income. Earned income includes things such as wages, salary, commissions, tips, bonuses, self-employment income, and nontaxable combat pay (this goes for adults as well as kiddos). As you can see, “allowance” from parents is not part of this. Nor are things like passive income - such as interest or dividends earned. wELl hOw WoUlD tHe iRs eVeN kNoW? First – that type of question is what tax fraud strategies are built around, so stop thinking that way. Second - through matching of IDs. When you have a Roth, certain forms are submitted which include information on the holder of the account, such as their SSN. All the types of earned income listed above are submitted via third parties to the IRS, so the IRS will know in most instances if you have earned income or not. However - there is now an exception to this limitation on contributing to a Roth for a child without the need for earned income. Starting in 2024, 529 plans, which were designed to save for educational needs, will be eligible for roll-over into a Roth IRA for the beneficiary if the 529 plan has been owned at least 15 years. It has a lifetime limit of rolling over $35k and is subject to annual Roth IRA contribution limits. So if you’re stuck with a 529 that wasn’t used for education or isn’t likely to be used for education, you now have an option to roll it over into a Roth IRA after the time requirement is passed and up to the 35K limit. Check with your tax preparer before rolling over your 529, to make sure this move makes sense for you and that the transfer is completed properly.
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