Hello there friends! Today, Im going to be diving into a topic im very excited about! Im of course talking about how to structure and open a business, hire your children as W-2 employees, and take advantage of tax benefits to help them build a financial foundation early on, exciting I know! This approach not only provides valuable work experience for your kids but also allows you to contribute to a Roth IRA on their behalf, teach them entrepreneurial and financial literacy skills setting them up for long-term financial success. Just remember I am not a financial expert and I do not claim to be one, im just some guy on the internet, so go do more research! That's not to say that what im about to share with you isnt just the bees knees so keep reading.
So, where do we start....
Steps to Starting Your Business
The first step is to choose a business because if you dont know what service or product you want to sell then you have no business, so start brainstorming. The next step is to come up with a name. These initial steps are great places to involve your kids so that they feel part of the business.
Now it's time to choose a business Structure. Decide whether to operate as a sole proprietorship, LLC, or corporation. Each structure has different tax implications, legal protections, and administrative requirements.
Sole Proprietorship: Simplest to set up, but offers no personal liability protection.
LLC (Limited Liability Company): Provides liability protection and is relatively easy to manage.
Corporation: More complex, but may offer additional tax advantages and is often preferred for larger businesses. (not us)
Once you decide on the business structure you will need to Register Your Business. This means you will need to file the necessary paperwork with your state to legally establish your business. This typically involves registering your business name and obtaining an Employer Identification Number (EIN) from the IRS, which is required for tax filings and hiring employees.
Next we will want to set up our business finances. Open a separate business bank account to keep personal and business finances separate. Consider using accounting software like QuickBooks or FreshBooks to track income, expenses, and payroll.
Now that we have an idea of some of the basics, its time to get into the details and create a business plan. You will want to outline your business goals, target market, and strategies for growth. A well-thought-out plan can help you stay on track and make informed decisions as your business evolves.
Activity #1: Brainstorm session. Sit down with your kids and do a brainstorming session on what kind of business you will have. You might already know what kind of business you are going to start, but this is your chance to let your kids get creative and throw out as many ideas for a business as they can think of, it doesn't matter if they are completely unrealistic the goal here is to let your kids get creative and get as many ideas as possible.
Activity #2: This activity builds on activity #1. Now that you have a list of business ideas grab a snack and sit down with your little ones and talk them through each idea and why it may or not work. Allow them to come to the conclusion, you can and should be guiding them of course.
Activity # 3: Create Your Family Business Plan
One of the main objectives of these activities is to empower your children and give them the confidence to be successful and by allowing them to take the business from an idea to an actual income producing business. This is a really powerful experience and could be the catalyst for many other great things.
Hiring Your Kids as W-2 Employees
Why Hire Your Kids?
Hiring your children as W-2 employees allows you to pay them a salary, which they can use for personal expenses or save for the future. The wages paid to your children are considered a business expense, which reduces your taxable income, but more on that later. When you hire your kids you can pay them up to $14,600 and write it off on your taxes as a business expense, plus since this amount matches the single deduction, the child will pay no federal taxes. The best part of all is that your children will now have earned income and can invest open a roth IRA and start earning tax free money!
How to Hire Your Kids Legally
First things first, the work your children do must be necessary and directly related to your business operations. Examples of legitimate jobs include managing social media accounts, assisting with customer service, or handling product packaging and shipping.
Now for wages, you cant just pay your kids whatever you want. You must pay your children a reasonable wage based on the work they perform. Their salary should be in line with what you would pay a non-family member for similar tasks. The IRS scrutinizes payments to family members, so it’s crucial to ensure that wages are appropriate and justified.
When you hire your kids (and any other employee for that matter) you must maintain meticulous records of the hours your children work, the tasks they perform, and the wages they receive. Proper documentation is essential to demonstrate compliance with labor laws and tax regulations. This includes keeping time sheets, employment agreements, and payroll records. Dont think that because they are your kids you can skip anything...you cant!
Taking Advantage of Tax Benefit
I touched on this earlier, but wanted to discuss a little more. Wages paid to your children are deductible as a business expense, which lowers your overall taxable income. This strategy allows you to keep more of your business earnings by reducing the amount subject to higher tax rates. Plus the money is going to your kids!
Example: If you pay your child $12,000 per year, you can deduct that amount from your business income, potentially saving thousands in taxes. This income is taxed at your child’s lower rate, maximizing your family’s overall tax efficiency.
Quick note: I am only a guy on the internet, so If I were you I would consult with a financial expert on any tax or finance related topic discussed in this blog.
Maximizing Roth IRA Contributions
Once your child has earned income from their job, they become eligible to contribute to a Roth IRA. Roth IRAs are powerful tools for building wealth because contributions grow tax-free, and qualified withdrawals in retirement are also tax-free. Not only that but after 5 years you can withdraw your contributions without penalty ( but i wouldnt recommend this, you/they will be missing out on a lot of compound interest.) As long as your child has earned income, they can contribute to a Roth IRA. For 2024, the maximum contribution is $6,500 or the total amount of earned income, whichever is lower. Starting early allows your child to benefit from decades of compound growth, potentially turning even modest contributions into a substantial tax free nest egg.
Long-Term Benefits for Your Child
Building Wealth Early
By starting a Roth IRA as soon as your child begins earning income, you leverage the power of compound interest over an extended period. Even small, consistent contributions can grow significantly, providing your child with a solid financial foundation. Example: A 15-year-old who contributes $6,500 annually to a Roth IRA and earns an average annual return of 7% could accumulate over $1 million by the time they reach age 65. This scenario highlights the impact of time and compounding on long-term wealth building.
Teaching Financial Responsibility
Involving your children in the family business and their own retirement planning teaches them about money management, the value of hard work, and the importance of saving for the future. These experiences instill lifelong financial habits and a strong work ethic.
Steps to Open a Roth IRA for Your Child
Once you have figured out the business aspect of things you can move on to focusing on opening a roth ira account for your kids. So where do we start? Lets look at the options we have when choosing a provider. Numerous financial institutions offer Roth IRAs for minors, often referred to as "custodial Roth IRAs." As the parent or guardian, you will manage the account until your child reaches the age of majority, which is typically 18 or 21, depending on your state.
Considerations:
Fees: Seek out accounts with minimal or no fees to ensure that more of your child’s contributions go toward their investments rather than administrative costs.
Investment Options: Look for providers that offer a broad range of investment options, such as index funds, ETFs, and individual stocks. Flexibility in investment choices allows for better portfolio diversification and alignment with your child’s risk tolerance and financial goals.
Below is a comparison of a few different platforms that offer custodial Roth Ira's. This is just a very brief summery of these platforms and i would encourage you to look deeper into these and other platforms when making your decision.
Vanguard
Fees: $0 account service fee for Roth IRAs; low expense ratios on index funds.
Investment Options: Offers a wide range of index funds and ETFs, making it an excellent choice for long-term, passive investing.
Advantages: Vanguard is renowned for its low-cost investing approach, particularly beneficial for those seeking a hands-off, long-term strategy.
Disadvantages: The minimum investment amounts required by Vanguard might be higher compared to other platforms, which could be a barrier for starting small.
Fidelity
Fees: No account fees; zero commissions on U.S. stock, ETF, and options trades.
Investment Options: Fidelity provides a broad selection of mutual funds, index funds, and individual stocks, catering to various investment styles and preferences.
Advantages: Fidelity’s platform is user-friendly and offers strong educational resources aimed at young investors, making it ideal for beginners.
Disadvantages: The vast array of investment options can be overwhelming for those new to investing, requiring some guidance or prior knowledge to navigate effectively.
Charles Schwab
Fees: No account fees; no commission fees for online stock, ETF, or option trades.
Investment Options: Schwab offers a wide variety of funds, including fractional shares, which enable small-scale investors to diversify their portfolios.
Advantages: The availability of fractional shares makes it easier for your child to invest in high-priced stocks without needing large sums of money.
Disadvantages: Schwab’s research tools are more advanced and may be too complex for younger or less experienced investors to use effectively.
TD Ameritrade
Fees: No account maintenance fees; no minimum balance requirements; free trades on stocks and ETFs.
Investment: Offers an extensive range of investment choices, including stocks, bonds, ETFs, and mutual funds.
Advantages: TD Ameritrade’s platform is highly user-friendly, with robust educational content designed to help young investors learn the ropes.
Disadvantages: The sheer volume of options available might be daunting for those just starting out, requiring time to explore and understand the platform’s offerings.
M1 Finance
Fees: No commission fees; no account fees, with an optional premium service (M1 Plus) for additional features.
Investment Options: M1 Finance allows for fractional shares and offers a customizable “pie” investing model, enabling the creation of a tailored portfolio of ETFs and individual stocks.
Advantages: The flexibility of M1’s platform is ideal for investors who want to create a personalized, diversified portfolio with automated contributions.
Disadvantages: M1 Finance has limited options for conservative investments like bonds, and the interface may be complex for younger users to navigate without assistance.
This comparison provides a range of options for opening a Roth IRA for your child, each with its strengths depending on your investment strategy, needs, and level of comfort with investing services.
Opening the Account
Gather Required Information: You’ll need your child’s Social Security number and proof of earned income, such as pay stubs or tax forms, to open the account.
Complete the Application: Most financial institutions allow you to complete the application online. As the account custodian, you will manage the investments and contributions until your child reaches adulthood.
Fund the Account: Once the Roth IRA is set up, you can transfer your child’s earned income into the account. If possible, set up automatic contributions to build a consistent savings habit.
Tools and Resources for Managing Your Family Business and Finances
Accounting Software: Tools like the ones mentioned earlier, QuickBooks or FreshBooks are invaluable for managing payroll, tracking expenses, and ensuring compliance with tax laws. These platforms offer features tailored to small businesses, including invoicing, expense tracking, and financial reporting.
Payroll Services: Consider using a payroll service such as Gusto or ADP to handle W-2 filings, tax withholdings, and direct deposits. These services can simplify the administrative burden of hiring and paying employees, ensuring accuracy and compliance. For me this is an absolute must in order to keep everything moving smoothly...especially since I dont have the know how or the time to do it myself.
Roth IRA Calculators: Online calculators, such as those provided by Fidelity or Vanguard, can help you project how your child’s Roth IRA contributions will grow over time. These tools illustrate the long-term benefits of starting early and can be a great educational resource for your child. You can play around with the numbers to fit different scenarios.
Financial Literacy Education: Encourage your child to deepen their understanding of investing and financial planning through books, online courses, or educational apps. Resources like Fidelity’s Youth Account, Greenlight, or Khan Academy’s finance courses are excellent for young learners. WeBull also has a great paper trading feature where kids can learn how to invest in the stock market with paper trading.
Activity: Once your child receives their first pay check, it's time to set up their Roth IRA
Summary
1. Brainstorm business ideas and decide on business structure
do a brainstorming session with your kids and let their imagination run wild, they may not yet know what is and what is not possible, use that to your advantage
2. Create a Business Plan:
Outline your business idea, goals, and the role your child will play in the operation. This should include a detailed job description, expected hours, and the compensation plan.
Determine how much you will pay your child based on industry standards and the nature of the work they will perform.
3. Set Up Business Finances:
Open a business bank account separate from your personal finances and choose accounting software to track your income and expenses accurately.
Register for an EIN with the IRS if you haven’t already, as this is necessary for tax reporting and hiring employees.
4. Hire your children as a w2 employee.
make sure to do your research on all the requirements for hiring a minor
hire a payroll service provider
track everything
5. Open a Roth IRA for Your Child:
Research and choose a financial institution that aligns with your investment goals and open a custodial Roth IRA for your child.
Make the initial contribution based on your child’s earned income and discuss the importance of regular contributions and long-term growth with them.
Use online calculators to show your child how their contributions can grow over time, emphasizing the benefits of starting early.
I know there is a lot of content here, so if you decide you want to give this a try, remember kids have short attention spans, so dont count on finishing this project in one, two, or even 4 sessions. Take as long as you need to do your research, what I provided is only a the first stepping stone in the journey!
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This blog combines practical business strategies with early financial education, providing a roadmap for building wealth as a family while instilling valuable lessons in your children. By following these steps, you can create a thriving family business that not only generates income but also sets the stage for your children’s long-term financial success. Of course this is easier said than done. I am currently in the process of doing just this with my family and will be posting updates as we complete different steps of the plan outlined above.
Dont forget to share your thoughts below in the comments oh and subscribe to the blog please =)
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