Your Baby Needs a Retirement Account

If Your Child Is Working

Traditional IRAs offer tax-deferred investing, in exchange for a tax deduction now. If your child is working, a tax deduction, though not essential, can be quite nice. Here's a quick example. Let's say your industrious child manages to earn $10,000 a year. A child under the age of eighteen gets a standard deduction of $4,550. So, at the end of the tax year, the child must pay tax on a total of $5,450. (This is a simple calculation of $10,000- 4,550.) At their tax rate of 15 percent, your little worker bee will owe $817 in taxes. But wait, there's more. If your child deposits $2,000 into an IRA, she would immediately lower her income to $8,000. After her deduction of $4,550, her taxable income is now reduced to $3,450. At her 15 percent tax rate, her tax bill is now only $517. Plus she has the money working for her, tax-deferred, for a very long time.

An IRA for the Future Student

Don't forget the Education IRA, which is a special type of investment retirement account designed to let you invest tax-deferred and withdraw money tax-free for the benefit of a child in your family. Until recently, they've been a bit limiting. You could only deposit $500 a year for each child, and you could only contribute to an Education IRA if your modified adjusted gross income for the taxable year was no more than $95,000 as an individual, or $150,000 for married taxpayers filing jointly. Starting next year, things will be looking up. Thanks to the new tax plan, you'll be able to invest $2,000 a year per child in an Education IRA, and you'll be able to put the money toward the cost of kindergarten through high school, not just the cost of higher education. And, AGI levels have increased slightly, so check with your bank or brokerage to see if you qualify.

Unlike a traditional IRA, you don't get a tax deduction for your contributions. Distributions must be used for approved education expenses, or you will be paying taxes and penalties.

Don't underestimate the power of tax free growth. If you open up an Education IRA for your newborn and deposit $500 a year at 10 percent, in 18 years you'll have accumulated $18,300, give or take. If you had to pay taxes on it (at the 28 percent bracket) then you'd only have $15,100. (If you deposit the maximum of $2,000, you'd have 73,213 tax free. $60,433 if you had to pay taxes.) That's a nice little tax benefit, and it was all rather painlessly accumulated.

The Wealthy Family

If all this talk about long term investing for your new baby gets you thinking about your own retirement accounts, then so much the better. Remember, you don't have to stop just because your 401(k) is maxed out or you are no longer eligible for an IRA. Contribute to your own investment account, and sock a little bit away, every month. Even in a taxable account, a little will go a long, long way. Bottom line, if you make long term investing a family affair, you will all be wealthier and wiser.