Roth IRA for your children and reduce your business taxes!

From JBrooks Wealth Advisors, PC.

The tax strategies in this article involve hiring your child  through your corporate or partnership and then having your child fund a Roth IRA.



Because the $5,000 was not taxable to  Jill  (or Jack), they invest the $5,000 in a Roth IRA, for which they receives no tax deduction for her contribution.

Let’s stop here for a moment. At this point, the government has paid you $1,950 to put $5,000 in your child’s Roth IRA, which is going to become part of her college fund.1

10 Years Later

Here we are, 10 years later. For each of the 10 years, your daughter invested her tax-free

earnings in her Roth IRA that earned an average return of 5 percent a year. She now has $74,785 in her account. You invested your tax deductions in your business, or in some other manner, and earned an aftertax return of 5 percent a year, giving you $29,088.

To put this in a different light, the government paid you $29,088 so you could help your daughter accumulate a $74,586 college fund nest egg.

Tax Law Rules on Roth IRA Withdrawal for Education

There are three tax rules that you should know regarding your daughter’s early withdrawal of Roth IRA funds.

Rule 1. Early distributions from a Roth IRA are subject to a 10 percent penalty tax;3 however, an early distribution escapes the penalty tax to the extent your daughter incurs qualified higher education costs for the year.4

Example. Your daughter withdraws $10,000 from the Roth IRA and incurs $20,000 of qualified higher educational costs for the year. She incurs no penalties because her educational costs of $20,000 exceed her $10,000 Roth IRA withdrawal.

On the other hand, say your daughter withdraws $31,000 from the Roth IRA and incurs $20,000 of qualified higher educational costs for the year. She is liable for the 10 percent penalty tax on $11,000 ($31,000 minus $20,000).

Rule 2. The Roth IRA distribution rules say that your daughter’s withdrawal first comes from her invested basis in the Roth.5 Thus, she can take out the $55,000 she invested with zero income tax. (Keep in mind that this is the $55,000 that you deducted as a wage and on which your daughter paid zero federal income taxes.)

Rule 3. The monies your daughter withdraws in excess of her $55,000 basis are from earnings that took place inside the Roth. The inside earnings that she withdraws are subject to income taxes.6

Planning note. Your daughter could easily be in the zero income-tax bracket for the first

withdrawals of taxable money because of the standard deduction (currently $5,800). Then, after her use of the standard deduction, she starts paying tax in the 10 percent tax bracket.

You can see that with some planning, she can avoid and mitigate the tax bite on the Roth IRA’s



And then you have the nice tax breaks, which include both the penalty tax escape to the extent of

higher education expenses and the tax-free withdrawal of basis.

Jeff Brooks, CPA 


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About Jeffrey Brooks

Jeffrey Brooks, CPA, CFP, MBA since 1976 has specialized in helping clients save significant taxes, help businesses increase their cash flow, revenues and profits while increasing their control and satisfaction. Jeff and his accounting firm sincerely cares about the happiness of his clients.

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Address: 4647 N 32nd Street, Suite B245
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Phone: 602-292-2009