Small business owners may find it challenging to find ways to provide additional benefits to their children who work for the company. One often overlooked choice is including a Roth individual retirement account (IRA) as part of their compensation, a strategy that offers the potential to benefit both the children and the business.
Small businesses play a significant role in labor markets. They employ 61.7 million Americans, 46.4 percent of all private-sector employees. Since 1995, small businesses have been responsible for generating 17.3 million net new jobs, which accounts for an impressive 62.7 percent of all jobs created in this time period.1
The Basics of a Roth IRA
A Roth IRA is a tax-advantaged investment account that allows individuals to contribute after-tax income. Unlike in traditional IRAs, contributions to a Roth IRA are not tax deductible, as their advantage lies in the tax-free growth potential and tax-free withdrawals in retirement.
Roth IRA contributions are phased out for taxpayers with adjusted gross incomes (AGIs) above a certain amount. To qualify for the tax-free and penalty-free withdrawal of earnings, Roth IRA distributions must meet a five-year holding requirement and occur after age 59½. Tax-free and penalty-free withdrawals can be taken prior to age 59½ under certain circumstances as well. The original Roth IRA owner is not required to take minimum annual withdrawals.
Utilizing a Roth IRA for Compensation
To contribute to a Roth IRA, the working family member must have earned income. This requirement creates a unique opportunity for small business owners to include their children as employees and compensate them accordingly. Because children are typically in a very low tax bracket, little tax is usually paid up front, allowing more of the money to grow tax‑free inside the Roth IRA.
Building a Foundation for the Future
Not everyone realizes that Roth IRA contributions can be withdrawn at any time, and that in certain situations, earnings may also be accessed before age 59½, such as a limited amount for a first‑time home purchase or for qualified education and medical expenses, depending on the rules. Consistent contributions from a young age can grow into a meaningful long‑term resource.
Seeding Financial Success
Although the initial contributions may seem small, the long-term benefits of including a Roth IRA in a child’s compensation package are significant. It not only establishes a solid financial foundation but can also instill valuable lessons about saving, investing, and preparing for the future.
Seeding Financial Success
- Advocacy.sba.gov, March 7, 2023
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