How much can my child, Chloe, earn tax-free in 2022?
Chloe’s salary for 2022 should be $12,950.00, the same amount as the standard deduction for a single person for the year.
Should I set my child, Chloe, with a Roth IRA or a 401K?
For most children, a Roth IRA is the right choice.
The two types of accounts offer tax advantages, the main difference being whether you want to pay taxes now or later.
With a traditional IRA, your contributions lower your taxable income for the current year. The money is then invested, and when you take it out after age 59½, you owe income taxes, and you’ve deferred your tax bill like a workplace 401(k).
With a Roth IRA, you invest money that’s already been taxed. When you withdraw it in retirement, you get the gains tax-free, assuming you follow the withdrawal requirements.
You’ve pre-paid your taxes. If you are in a low tax bracket now and expect your income to grow over your career — and thus reach a higher tax bracket — it makes sense to contribute to a Roth and lock in that low tax rate now.
Plus, income tax rates are generally lower now, thanks to the 2017 tax law changes, making Roths even more attractive. It is almost certain that tax rates will eventually increase.
Another perk of Roths
You can think of it as a backup emergency account. If you need to, you can withdraw your contributions at any time, Tax and penalty-free (any investment gains you withdraw early will be taxed). On the other hand, tapping into a 401(k) or a traditional IRA in an emergency means paying a 10% early withdrawal penalty, plus whatever taxes you owe (with some exclusions).