Money Matters: Tired of toys, gadgets? Give a gift worth thousands

Every year parents are on the search for the newest, hottest or hippest gifts for their children. Often, the hot gifts are in limited supply, and you find yourself filling gifts boxes with other items only to purchase the hot item after Christmas as well. While it may not garner cheers and jumping for joy, you might try a gift worth thousands this year.

What gift is worth thousands? It is a contribution to an IRA, individual retirement account. If you have a teenager who has "earned" income during 2006, they are eligible to make a contribution to a retirement account. If you are not sure what could be considered earned income, it is typically the W-2 earnings from their summer job. However, it can also be the profit from a summer mowing job or other types of work that would normally be considered self-employment earnings. If your child had self-employment type earnings, they will have to file a Schedule C form with their 2006 tax return in order to declare the earned income. If they have a W-2, the Internal Revenue Service is already aware of their earned income,
because the employer files a copy of the W-2 with the agency.

The fact may come up that the child no longer has any cash left over from their summer work, thus how can they make a contribution to a retirement account? The IRS does not have regulations requiring the retirement contribution to come from funds owned by the account holder. This means parents or grandparents can provide the cash for the contribution.

The retirement contribution is limited by the amount of earned income for the child. Therefore, if their W-2 or profit from their Schedule C is $1,250.00, then the contribution can be any amount up to the amount of earnings. The maximum contribution for 2006 is the amount of their earned income or $4,000, whichever is LESS.

Okay, you are ready to be non-conventional and fund a retirement account for your child. Where do you go? Your child is age 14, 17, or 11, and you thought since they are under 18 they cannot have a retirement account. While some institutions may tell you they do not offer IRAs for individuals under 18, there are many that will open an account. You can open an IRA savings account with a bank or you can purchase mutual fund shares in many fund families. My recommendation for a childs retirement account would be shares in a mutual fund. The child has decades of time ahead of them, and thus the added risk of a mutual fund over a saving account should not be an issue.

If a mutual fund is used and a 10 percent return is achieved over time, an initial one time contribution can still grow to become worth thousands. If your child is 15, they have 50 years until the typical retirement age of 65. One of my favorite topics comes into play for your child, and that is time value of money. A contribution as small as $250 could grow to more than $29,000 by the time your child reaches 65. A single $1,000 contribution could be worth over $117,000.

Another question that may arise is which type of retirement account to use? You have a choice between the Traditional and the Roth. Since the child most likely will not actually owe taxes for 2006, the benefits of a deductible Traditional contribution are not required. Even if a small amount of tax is owed, most likely the tax-free income from the Roth retirement account will be more desirable than taxable income from the Traditional account. Thus, you should open the Roth, and the entire value at their retirement can be withdrawn income-tax free.

The last thing to remember, your child must have "earned" income in 2006; and to make sure there are few issues, they should file a 2006 tax return. The contribution can be made any time during 2006 all the way up to the initial due date of the tax return, which is usually April 15 of the following year. Start your child off with a great first step and encourage the funding of a retirement account. If you want assistance, contact my firm or one of the other financial professionals in our
area.

HOW TO REACH THE WRITER

Would you like a response to a financial question? Send your question to Doug Horn, 115 W. Broadway, Maryville TN 37801. Be sure to mark your envelope Money Matters.

Doug Horn, CFP, is an area financial planner with more than 21 years financial experience and founder of Quality Financial
Concepts, located in downtown Maryville on Broadway.

Doug Horn, CFP, Registered Investment Advisor in Tennessee and Texas and Registered Principal, Branch Office of and Securities offered through CUE Financial, Member NASD, SIPC.