Pay Your Kids and Fund a Roth IRA: A Practical Guide for Small Business Owners

Small business owners may pay their children for bona fide work and use those wages to support Roth IRA contributions. This approach creates a legitimate business deduction, potential payroll tax efficiencies, and long-term, tax-advantaged savings for the child. The sections below outline the key requirements, benefits, and practical next steps under current IRS guidance.

Eligibility and Compliance When Paying Your Child

• Bona fide work: Assign age-appropriate, necessary tasks (e.g., filing, inventory, cleaning, basic admin, social media support, product prep, photography).

• Reasonable pay: Set compensation at market rates for the work performed; document job descriptions and timesheets.

• Payroll setup: Complete Form W-4 and Form I-9, run regular payroll, and issue Form W-2 at year-end; maintain timesheets and proof of payment.

• Entity and payroll taxes:

• Labor laws: Follow federal and state child labor rules (hours, permitted duties, and school attendance requirements); state tax and wage rules may vary.

Roth IRA Rules for Minors

• Earned income requirement: The child must have earned income (e.g., W‑2 wages from your business). Keep payroll and bank records.

• Contribution limits: Contribute up to the lesser of the child’s earned income or the annual IRA limit (the limit is $7,000 for 2025; limits may change). Catch‑up contributions do not apply to minors.

• Custodial account: Open a custodial Roth IRA; a parent or guardian serves as custodian until the child reaches the age of majority under state law.

• Income limits: Roth IRA contributions are subject to MAGI phase-outs (for 2025, single filers begin phasing out at $150,000); this is typically not an issue for minors.

• Funding source: Parents may gift cash for the contribution as long as the child has earned income at least equal to the contribution amount.

Benefits and Long-Term Impact

• Business deduction: Wages are deductible to the business when ordinary, necessary, and reasonable.

• Potential payroll tax savings: In a qualifying sole proprietorship or parent‑only partnership, wages to a child under 18 may avoid FICA; under 21 may avoid FUTA.

• Low or no income tax for the child: If wages do not exceed the standard deduction, no federal income tax is due (single standard deduction is $15,750 in 2025; state rules vary).

• Tax-free compounding: Qualified Roth IRA withdrawals are tax-free; contributions (but not earnings) are withdrawable at any time without tax or penalty.

• Early financial foundation: The strategy builds savings habits and provides decades of potential tax-free growth.

• Illustrative example: One $3,000 contribution made at age 15 and compounded at 7% annually for 50 years could reach approximately $88,000 by age 65 (hypothetical; actual results will vary).

ACTION STEPS

• Define the job: List age-appropriate duties, required skills, and a reasonable hourly rate benchmarked to your local market.

• Set up payroll: Complete W‑4 and I‑9, add the child to payroll, track hours, and pay by check or direct deposit; issue a W‑2.

• Confirm entity treatment: Verify whether FICA/FUTA exemptions apply (sole proprietorship or parent‑only partnership) or if full payroll taxes apply (S/C corp or other partnerships).

• Open the account: Establish a custodial Roth IRA; choose low-cost, diversified investments aligned with long-term goals.

• Fund within limits: Contribute up to the lesser of earned income or the annual IRA limit; consider automating contributions.

• Maintain documentation: Keep job descriptions, timesheets, pay stubs, bank records, and IRA contribution confirmations.

• Review annually: Reassess pay rates, hours, labor law compliance, and updated IRS limits each year; adjust as needed.

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This material is for informational purposes only and does not constitute tax, legal, or investment advice. Federal and state laws, thresholds, and contribution limits may change, and outcomes may differ based on individual circumstances. Consult qualified tax, legal, and investment professionals regarding your specific facts, entity type, payroll requirements, and retirement planning decisions.