128: Kids on Payroll – A Tax & College Funding Strategy Part 1

Everybody to another episode of the Dental Boardroom podcast. It's Wes Reed, your host. I got a cool subject today. This is a tax planning and wealth building strategy that I've been using since day one of helping dental practice owners accumulate financial security in their life. And the topic is getting your kids on payroll inside of your practice. Now, if you don't have kids, this isn't going to be relevant right now. If you're planning to have kids, I would still listen to it because this is a tried and true easy, low hanging fruit for doctors to save money that would have gone to the IRS is now going to get rerouted back in their family pocket. So today we're going to talk about this as one of the smartest ways for a dental practice owner to reduce taxes, build generational wealth and it is employing your kids in your dental practice. This isn't just about shifting income into a lower tax bracket. It's really about funding your kids future through a Roth IRA or and or a 529 college savings plan with wages that they legitimately earn. The takeaway is that by doing this you're not only lowering your tax bill, you're also setting your kids up on a path of tax free retirement growth and or tax free education funding. Now I will say that the money going into your personal account from your practice due to the kids payroll doesn't necessarily have to go into a separate account for the kids. It literally could go into your own checking account. Personally I did it for many years and it doesn't also necessarily need to be used for education funding or for retirement planning. It could just be used to take care of them like putting food on the table. Today, however, I love to pair up this strategy of lowering your taxes by getting kids on payroll, by taking a portion of that or all of their payroll and putting it in these tax advantaged accounts which can be used for so many things later and if you start early enough. The tax deferred compound growth is absolutely remarkable. And I'll give you a few of those numbers today to put in perspective just how remarkable it can be. Again, this is a strategy we here at Practice CFO employ religiously across our clients. And we've never had an IRS audit issue before on this. And if it's done appropriate and follows the IRS rules, as I always say, we here at Practice cfo, our CFO advisors, that's what we call our team members who are meeting three, four times a year with our clients and doing a full financial analysis which includes a cash flow forecast a tax analysis, debt analysis, reviewing expense categories and budgeting analysis, and of course, how to fund the doctor's personal financial goals in their personal life. We really integrate the business and personal financial planning in a very unique way with the CPA back end that drives the data for us when we do our planning. That data is the accounting reports like the P and L and the balance sheet and also the tax returns and payroll reports. So all of that stuff that comes out of the CPA side is the financial X ray to do forecasting and planning such that you make good decisions today, within a year from now, five years from now, 10 years from now, you're going to be significantly better off because of the decisions made today. That's the nature of our role here at Practice cfo, being your business and personal chief financial officer in an outsourced, what it would call a fractional way. Now, this subject of putting kids on payroll is this is as routine as it gets. For this is like a filling for a dentist getting kids on payroll. There's a strategy to do it that works. That's right. And a strategy that doesn't work and could end up being harmful to you. So I hope to create clarity around this financial planning and tax strategy topic. Okay, let's go ahead and dive in. For those of you watching on YouTube, you can see what I am saying in kind of a visual format as well. And I will narrate this of course, for those not on YouTube. Are you looking to buy or sell a dental practice?

If you're a seller, how do you.

Find a strong list of potential buyers? There's no MLS or Zillow for dental practice sales. In such a fragmented market, many dentists.

Selling their practice feel discouraged.

That's why I built practiceOrbit.com practice orbit is modernizing how dental practices are bought and sold. It's a platform technology. Y' all know them. Zillow, Airbnb, Uber, and OpenTable, just to name a few. These technologies do two things. First, they help match buyers and sellers by centralizing the marketplace. Second, once the match between buyer and sellers made, these technologies help them navigate.

The sale to a successful close. Here are a few of the features.

Inside a Practice Orbit Users can determine.

A reasonable sale price for practice in just minutes.

All they need is the most recent business tax return. Practice owners can use the directory to.

Find important service providers like practice brokers, attorneys, accountants and bankers.

Practice owners and their brokers can invite those service providers into the platform.

So all parties are coordinating the sale together.

Practice owners will have a beautiful digital listing of their practice like a home on Redfin. And importantly the the listing will be anonymous and personal information like your address, name and pictures are only released after.

An NDA is signed and approved by.

You or your broker.

Practice buyers can create saved searches to.

Be auto notified when new listings come on the platform that fit their desired specialty and location. And hey dental practice brokers, you can list all your practices on the site for free. By doing so, you'll get access to Practice or Orbit's large pool of buyers.

All of whom have created profiles and.

Saved searches to be auto notified when new listings come for sale. You can use the platform to introduce.

Your listings to a targeted set of buyers.

Additionally and optionally, you can use the platform tools such as a built in.

NDA, a customizable LOI and a workflow.

Tool to navigate the sale from LOI to closing. In fact, you can manage all your listings on the system from listing the practice to NDA to loi and finally to closing the deal. Create your free account today at www.practiceorbit.com.

So the main goal here reduce taxes plus building family wealth and how we can fund our kids Roth IRAs and or 529s and do it in a tax compliant strategy. Now why to do this?

The reason why it saves in taxes is because we are shifting income from your tax bracket to your child's tax bracket and your children are going to be most likely, and I would hope so, in a lower tax bracket than you. If they're not in a lower tax bracket than you, it's because either they are a miracle child out there cranking, making $400,000 as a 14 year old, which I've never seen that before in my life. Or the most likely answer is you as the practice owner have a struggling practice a bit and the cash flows may be very low or negative and so your practice really isn't generating much taxable income and therefore your tax bracket is very very low. But in most cases, 98% of the cases with dental practice owners and 100% of the cases with practice CFO clients, the parents are in a higher tax bracket than the kids. And you may even be saying what do you mean Wes? My kids aren't. They don't have a tax bracket because they don't have income. Well, they do. It just means their tax bracket is zero. They're not paying any taxes. But as soon as they start earning money, it doesn't matter if they're 8 years old or 18 years old, they're going to have to file a tax return or pay taxes now, if it's under a certain level, they actually don't have to file a federal tax return. So I'm going to talk about that in this podcast episode today. But the main point in lowering taxes is that you're shifting income to a lower tax bracket. You may be in the marginal. Marginal and what I mean by marginal. It's important to know this as a business owner. The next dollar of taxable profits is taxed at your marginal rate. And remember the tax code is like stairs. It's incremental. The first X amount of dollars is taxed at 10%, then 15% on the next step and it's a staged growth. So if you're taxable bracket, if you're married, filing joint and you are in the 700,000, so you're a very strong earner. That next dollar of profit you earn is going to be taxed at 37% Fed plus your state tax rate. If you're in California, that's probably going to be between 9 and 10%. And so your gross marginal tax rate is approaching 50% in that scenario. Hence the need for very good tax planning in order to beat the friction of tax payments to the irs. When you shift income to your child, they will be in a low or 0% income tax bracket. So I'm going to go into a little bit more detail on that as well and out of this podcast to also learn a little bit about the nature of these Roth IRA accounts. They're different than IRAs. Roth IRAs are amazing, especially when you're able to put money in there that you never pay taxes on, which is what's going to happen when you put your 12 year old on your payroll. And I'm going to show you how. I'll also talk a little about the rules of 529s on a high level because for a lot of our clients who are funding their kids through their practice payroll, a lot of times they're using that to fund their education savings through a 529 education savings plan. And then lastly, there could be a value to this depending on how much you actually involve your kids to teach work ethic and money skills. I definitely think that is another value that can be added to this strategy. Okay, let's talk about how the strategy works. More specifically.

I mentioned you're shifting income. Let me explain that. When you pay your child a dollar and it goes through payroll, that dollar is a tax deduction to your practice tax return. Now most of you are going to be set up as an 1120s tax return. That is a, that's an S corporation. Now you may be in a state that allows an LLC or a PA or a pllc. If you're in California, you're required to be a professional corporation. Whether you're an LLC or professional corporation or PLLC or pa, it doesn't matter. From a tax standpoint standpoint, it's all the same. That's just a state level liability protection designation and determines how much sort of mechanical administration work you need to do around your entity. If you're an llc, for example, you don't have to file corporate minutes. So any state that allows an llc, we prefer that. But in terms of your tax return, there's no such thing as an LLC tax return. You have to file as either a sole prop, a partnership or a corporation. In which case for virtually all of our single doctor owners, single sort of owner clients, that is non partnerships, they will file as an S corporation.

And as an S corporation, you have expenses. Your labor, your labs, your supplies, your facilities. These are all expenses that lower your tax bracket. When you put your kids on payroll, it's an expense on your P and L. In other words, it reduces your taxable income. So if your taxable income would have been $100,000 and then you decide to put your child on payroll and you get them one payroll, and for $1,000 on December 31st, your taxable income is now going to be $99,000 instead of $100,000. And if your taxable income is only $99,000, guess what? You're going to pay lower taxes than on the $100,000. So the question becomes how much should you pay your children? Here's the strategy. The you're you could probably pay your child a lot of money, 100,000, 150,000. And they would be in a lower tax bracket than you. However, the more you pay them, the less the spread between your tax bracket and your kid's tax bracket. If you're in the highest tax bracket, you're going to be in 37%. If you're in the second highest tax bracket, you're going to be 35%. Your kids up to a certain amount federally are taxed at the 0% income tax bracket. For 20, 25, that number is 15,600 15,750. So if you pay your child 15,750 and they, and that is their only source of income because you know they're nine Years old. There's no other income, no paper out, nothing. That is their total taxable income, 15,750. And they're going to get a W2 from your payroll provider showing 15,750 with their name on it. Now, what the IRS gives every taxpayer, really, every human, anybody who breathes, that is a human, gets this thing called a standard deduction. A standard deduction, it's just a free immediate reduction up to a certain level of your income. And it goes up every year. This year, 2025, it's 15,750. I bet by next year, 2026, it may go up to 16,000, 16,500 or so. And it just sort of rises. There was a time when it was only 7 or 8,000, but it goes up every year. This year it's 15,000 7 50. So you pay your child 15,000 7 50, you reduce your taxable income by 15,000 7 50. And your child doesn't pay any federal income tax on it because they get a standard deduction for that exact amount of 15,007 50. So if you end up paying them 20,000, well, yeah, then they're going to owe taxes on 4,250, which is the difference between 20,000 and 15,750. So we usually don't want them to even have to file a federal tax return. And if they don't owe any income, they actually legally don't have to file a 1040 federal tax return. That's pretty cool because there's always a filing fee. And if you go to H and R block or even if you use TurboTax or you come to a professional firm like ours, there is a fee to pay to file a 1040 tax return. Now, if you pay your kid only the standard deduction or less, you don't have to even file a federal tax return. Now, that's only half the story. The other half of the story is depending on your state's standard deduction, you may have to file a state return. For example, in California, the state standard deduction, I think it's somewhere around 5 or 6,000.

And therefore the 15,750 of income is above that number. So there will be a small state tax. Now, most state tax is less than 5%. And in a number of states like Florida, Texas, Alaska, it's zero. And so there's no state taxes there, and therefore no income tax return needs to be filed federal or state, if it's in a no state tax state. However, if you're In California, you know.

You may owe a few hundred dollars on that $15,750 of income. Here's the other thing that needs to be considered that is an offset to the strategy. It's that even if your child earned a dollar, they have to pay certain other payroll taxes related to that dollar that are not income taxes. You see, income tax is just one of the layers of taxes that we pay in this country. There are also FICA taxes, and that is Social Security and Medicare, and that's 15.3% on that dollar. So that dollar is going to be subject to 15 cents. 15.3 cents is the FICA taxes on that dollar. And then sometimes there's some unemployment tax that might be added, maybe a local tax that's added. So when you add that up, it usually ends up being around, I would say around 12 to 14%. Now, the reason why I just mentioned it's 15.3%, but the true cost is less than that. It's because the employer portion of fica, which is Social Security and Medicare, is tax deductible. So even though your payroll company is going to remit a little bit of FICA taxes on this pay to your kids, you're going to get a tax deduction on that. So bottom line, here's the bottom line. If any of that was confusing, here's the bottom line. If you pay your child 15,000 7 50, they're depending on the state, they're probably going to owe somewhere around.

15% on that, 15% on that. So let's if I pull out my calculator And I say 15, 750 times 0.15, in that case, we're looking at $2,362 in FICA taxes. You could say, well, actually that's not bad because my child is going to start getting Social Security credit very early, which could help later on, many, many years later on benefit from Social Security credit. Now the key thing though is what are you saving from an income tax standpoint? If you are In a, let's say 35% federal marginal tax bracket, that's the second highest bracket. And let's say your state is 4.4%. So we're going to say 39% to total times 15,750 equals 6,142 less the roughly 2,200, it's about $4,000. Now, there might be a few extra incidental costs. Maybe there's a direct deposit fee from the payroll company for a dollar per deposit, yada yada, but it should save you somewhere around, on the low end, $3,000, and on the high end, somewhere around $4,000 per child after paying the related FICA taxes on their payroll. So it is an easy slam dunk. It moves income that would have been taxed at a somewhere between 35 and 50% tax bracket to essentially a 15% tax bracket when you combine income and FICA taxes together in the analysis. So that that's how it works. It's income shifting from one part of the tax bracket to a much lower part of the tax bracket. And you really ideally want to do it for each child at the level of the standard deduction for that year, which again, this year is 15,007, 50. And the higher that goes, the more benefit you get from a tax saving standpoint.

Okay, now, does your child actually need to be working in the practice? Well, if you're audited, the answer is going to be yes, because you can't just pay a child with no.

Without any underlying reason, without the IRS saying, wait, that's just a pure tax strategy that has no substance behind it. We're going to disallow it and maybe add a little bit of penalty on there. I have not, in the roughly 17 years I've been doing this, I have not seen a single audit on this issue. We've had some audits, but not on this issue. So here's how you protect yourself. A, you have your child, you create a work task list for your child that can be taking out trash, that can be vacuuming, that kind of thing. And personally, I think it's a good idea once a month to have them come in and do a little bit of cleaning, even if you already have a cleaner. Just teach some work ethic. I think it's a wonderful thing for kids to do that. Plus, they come in and they get to see where does mom or dad work, and they become a part of that a little bit, and it adds to the relationship. I personally have found that with my own kids, I've involved them in some things in my business over the years to sort of justify the same strategy that I've been doing for about 15 years, essentially since I started, really. And the second thing is you could get pictures of them, put those pictures around the office with nice smiles and call it modeling. And this is a very common thing that people will do in order to say, this is a modeling fee. I pay for my child, who did the modeling. Now, the IRS can't come in and tell you who you can hire and who you can't hire. There's nothing preventing you from being able to hire your kids to do certain work. And in fact, if you do have them doing work for you, the IRS wants you to put that through payroll anyways. It's just a matter of having a list of what they are doing and ideally you have something that shows some sort of evidence that they're doing it. But again, the outer risk here is extremely low. Extremely low. I've probably saved over the years of doing this, let's see, maybe 8 to 10,000 a year for 15 years plus the investment. I mean this probably saved me 200, $250,000. My oldest son just left college, he's 20 and I have a daughter who's 18 as well and then a 14 year old. So I've been doing it with three kids for quite some time actually.

Do you ever feel lost in your practice finances? And how about your personal finances? Ever wonder where your hard earned money goes and why you're not seeing the financial progress you've worked so hard for? If so, listen up. As a Dell CPA and financial plan planner, I've created our company Practice CFO just for you. With almost two decades of experience, Practice CFO integrates great CPA services like accounting and tax with customized financial planning, both business and personal. Think of it this way. Our dental focused CPA services give us the x rays we need to clinically plan your global finances and be effective financial planners. It's a highly customized approach we call the CFO model. Historically, having a CFO or chief financial Officer was an advantage of large corporations only. But today, Practice CFO gives that same advantage to private dental practice owners. As a client of Practice cfo, you'll be assigned one of our dedicated CFO advisors. You'll receive insightful financial reports each month, have regular financial review meetings, reduce taxes.

Grow your wealth, and feel more in.

Charge of your numbers. Because we believe that in the competitive landscape of dental practice ownership today, you have to be an effective business owner, not just a capable clinician. Reach out to learn more at www.practicecfo.com.

Okay, let's now go through a little bit of the mechanics of this for a sec. Your kids need to be added in your software in your payroll software with your payroll company. As an employee, they should be a W2 employee, not an independent contractor. And they will not work enough to get benefits like 401k or health benefits. They won't need that because they're likely on your health plan, of course, but they're not really going to get a lot of those benefits and other costs that your standard employee has. So it's whatever processing cost the payroll company has. Now, if you set that up to be paid 24 times a year, that's twice a month or 26 times a year, that's every other week, then let's say they charge a couple bucks per employee, per payroll, then you might end up having, you know, $100, $150 payroll cost to put your child on payroll, which slightly erodes the benefit a little bit. You could pay them once a year in December for roughly around $18,000, such that after the FICA taxes come out, they are getting 15,000. Actually, no, I take that back. You would pay them exactly 15,750. Then after the FICA taxes come out, maybe a little bit of state income tax, let's say that leaves you 13,000 that gets deposited in your personal share checking account. So you could do it once a year. I think if you're audited, it looks a lot more valid and less as a pure tax strategy if you pay them monthly or even every payroll. So sort of a little audit prevention premium we'll call it would be to pay them on a regular basis through your payroll. What we typically do at practice CFO is the first payroll in January. We set it, we forget it. And so if it's 15,750 and there's 24 pay periods for the year, we will take 15,007 50 divided by 24. And that's what we will make the payroll for each child. And then depending on the state, will sometimes withhold 1 or 2% for state taxes, zero for federal taxes. And then, of course, FICA taxes come out naturally out of that very, very simple payroll structure. All right, now you've set it up in payroll. You've got the amount, the gross amount for the year that you're targeting on the W2. Again, you don't want to pay a dollar more than the standard deduction because if you do, then you actually have to file a 1040 tax return. If you don't, you don't even need to file a 1040 tax return. And by the way, if you are a sole proprietor, which generally I do not recommend being a sole proprietor. If you're an independent contractor and you're taking home under, let's say, $200,000, sure, you could be an independent contractor. If you're a practice owner and you're doing 600,000 in collections after expenses, you're under 200,000, probably better to be an independent contractor, not in. Probably better to be a sole proprietor and not a corporation because corporations have corporate tax fees. There's a certain state tax like California has additional tax taxes and some not big, but it has some additional taxes and administrative work. But if your income ends up being more than 200,000 sort of take home, you really need to start looking into being an S corporation. But if for any reason you're a sole proprietor and you pay your kids through your sole proprietorship of your practice, you actually don't even pay FICA taxes. So literally you're going from whatever tax bracket you're in, you, let's say you're in the combined 45% tax bracket, going from 45% to the 0% if you're in a tax free state. If you're in a state like California, your kids may pay, you know, 2 or 3% on that, but you're essentially making a huge transfer in or reduction in the tax percentage applied on that money you pay your kids. And if you have three, four kids and you're saving $3,500 each, that ends up being a, like a 10 to $12,000 tax, saving like $1,000 a month. That's beautiful. Then you take that extra thousand and you fund your retirement account or your kids, Ira, whatever, and you let that grow. It becomes you are parlaying one benefit, that is tax deduction a day into a future benefit of compounded growth in an investment account. Okay, let's talk about where should the direct deposit for your kids payroll go? Should it go into your checking account or should it go into your kids checking accounts? Now it's a bit of a pain in the booty to set up a checking account for your kid. Some banks don't even allow it. Other banks, you got to go into the bank, you got to bring some supporting documentation and it essentially becomes like a custodial account or a joint account. Most kids can't have their own independent account under a certain age, depending on the state. So a little bit of a pain in the butt historically. And what I typically recommend is just to have it deposited in the same account that your own direct deposit lands. So your own business, sorry, your own personal checking account, whether that's an individual account or a joint account with a spouse doesn't matter. I am perfectly fine setting it up to go there. So your kids never actually see this money. They don't have access to the money. They can't go use it to buy anything stupid. You have full control over this money. So if you have three kids on payroll and after the FICA taxes, let's say it's $12,000, that's $36,000, $3,000 a month. That's going to land in your personal checking account because of your kid's payroll. Okay, so we've established where it can go again. It can go in your kids accounts. If you want to set up an account for them, that's fine. I prefer to go into your personal account. All right, so once it's landed in that example of three kids, $36,000. Now what? Well, if you're struggling to make ends meet personally, you can just use that to cover your normal daily costs. That's fine. What you've done there, What I, what I would do there is if you're Normally taking home 12,000 from your own payroll in your practice and you're getting now 3,000amonth from your kids, I would simply lower yours to 9,000. Your kids 3,000 deposit adds to yours. And now you get two deposits every pay period, one for you and one for your kids. Actually would be four deposits, one deposit for each kid plus your normal deposit. And that tallies back up to the 12,000 and go and spend on your food, groceries, etc. To live. What I would love to do, my, my first preference though is you keep your own personal deposit at whatever it was to live on. Let's say that's $12,000 a month. Then we take this $3,000 a month for each of the kids and we do the following. You can set that up in a Roth IRA in the kid's name. So now we're going to pivot a little bit and talk about Roth IRAs. And Roth IRAs are amazing accounts. I love them. I have a Roth ira. I've been funding it since I graduated. You're limited on how much you can fund this year in 2025, it's $7,000 if you're under age 50, it's $8,000 if you're older than age 50. So talking about your kids, it's clearly going to be the $7,000 mark. And each child can fund up to $7,000 a year into their own Roth IRA in their name. Now it would be what's called a custodial Roth ira, where you as the parent are the custodian, meaning you have the control of that account. And, and frankly, most of my clients kids don't even know the account exists, to be honest. But the law is once they reach that age of independence, or what's their. The legal term is emancipated. In some states that's going to be 18, in some states that's going to be 21. That account legally needs to change from a custodial account to be an account directly in their name. And parents generally will lose access to that unless the child signs a document at the bank that holds the ira. Let's say that's Schwab, Fidelity, Vanguard, et cetera. Unless the child signs a document that allows the parent to still have access to and control the investments. But until they reach that age, it is completely in the control of US parents in these custodial accounts. Now, a child cannot fund, in fact, nobody can fund a Roth IRA unless they have W2 income. No W2 income, no ability to fund a Roth IRA unless you're self employed and a sole proprietor. Then you have what's called self employment income. Ignore that. If you're a corporation, you need W2 income in order to fund a Roth IRA. And so if you have a W2 of $7,000, then you can go and fund $7,000 into a Roth IRA. And if you have $15,000 of income, or in this case 15,007 50 for 2025, you can still only fund up to the $7,000 cap per person, cannot go above that amount. So if you have three kids and they're all at 15,000 750 gross W2 for the year, each of them, you could put in 7,000 into each of their custodial Roth IRA accounts. Now we set up a lot of these for our clients and we just do it automatically so our clients don't even need to blink. In fact, a lot of what we do at practice CFO is we just try to set all, what I call the piping in place. So all of this happens without my clients even having to think about it. Their job is to go and produce and manage a great culture and team. And then once the dollar hits the bank account and plink goes through their expenses and comes out on the other end. We pay taxes, debt, personal budgets, etc. That's where we, we really kick in and automate the, the building of wealth through debt, pay down and funding investments. And the Roth IRA has got to be my favorite investment account, period.

So the money has come into your personal account from your kids. Let's say you're, you're now in, in, in January, the year is over and in the prior year you funded 15,750 for each of your kids. And that money ended up being about 36,000 net collectively across all of the kids. And it's just, theoretically, it's just sitting there in your personal checking account. What can you do? Well, the Roth IRA, you have until April 15th to fund that Roth IRA of the following year. So if you're in January, the year's up, your kids all have a W2 of 15,750. Let's say it's January 2026. And now you can take the money and you can go and put it in their Roth IRAs. You can set that up. If you're with us, we set that up at Charles Schwab. You can do it at Vanguard Fidelity, probably Robin Hood or, you know, any of any bank out there that allows a Roth ira, you can go do that.

And you may be thinking, though, well, Wes, do I need to keep the kids payroll deposits partitioned off separately from my own payroll deposit somehow? The answer is no. It's going to get blended in your bank checking, your personal checking account with everything else going in there and coming out. And so what I like to do is just once a year, you know, you're going to do the W2 for your kids. You don't have to wait for the year is over to fund the Roth IRA. Just go fund their Roth IRA for the $7,000 from your personal account. It's in their name, and there's a little bit of paperwork. It's not difficult. And just fund it once a year. Theoretically, you could have the payroll direct deposit go immediately and directly into the Roth ira. I just don't like that because you have to. Then at the point in time when the Roth IRA hits 7,000, you have to go into your payroll software and turn it off and switch it to a different account. And anything that's manual like that, it gets forgotten about. It adds administrative. Administrative burden. We don't want that. We don't want that. That's why I prefer just once a year, plop in the $7,000 to each kid's 520. Sorry, education. Ah, sorry. Roth IRA accounts. You can do it at the same time that you fund your own Roth IRA accounts for you and your spouse. If you're a savvy investor and you don't have a large regular IRA, you can do the backdoor Roth contribution for 7,000 or 8,000 if you're older than age 50. And there's actually some new contribution rules I'm not going to get into right now with the one big beautiful bill, the obbb.

That passed recently that's for a separate podcast, just focusing on the kids right now. Okay. Now the question becomes, how do you invest that money? Well, that also is probably for another podcast episode. But what I would say is the money that's in the Roth ira. Let's actually dwell on this a little bit longer. What are you going to use that for? What can you use that money for? Well, the Roth IRA grows tax free. And when I say tax free, that's different than tax deferred. Like a regular IRA or a regular 401k tax deferred means it's in there and you didn't pay taxes on the money that went in there. So you got a tax savings in the year that you funded it. But eventually you pull that money out and when you turn 59 and a half, you can start pulling it out. And then when you hit a certain age, usually you have to start pulling it out. Right now that's currently at 72, age 72, you have to take them, they're called, require minimum distributions out of your regular ira. However, if it's a Roth ira, you don't have to take distribution. You could literally die at age 95 never having taken out a single dollar from that Roth ira. And then it gets inherited from your, your kids or whoever you give that to. Regular IRAs have to be, you have to, you have to do that.

So the Roth IRA is a great account for two things. One, funding education. I think it's better than a 529 education account from that standpoint. Because if your child doesn't need education, they don't need support. Maybe they have a scholarship, maybe they just come out and are like, you know, killing it in some AI tech and they don't even go to college, or they go to a junior college for a couple years and they end up not needing that much for their college, whatever. If they don't actually need it to fund college, the Roth IRA is much better because the Roth IRA money can literally be used for anything up to the contributions you can pull out for anything. Now, a little bit of a caveat on that. If it's before age 59 and a half, there are certain things that you literally pay no, no tax or penalty on, like first time, certain amount, first time home purchase, for example, or college costs. You don't pay anything. If you pull it out to go buy a boat, there's going to be a 10% penalty on there because you're pulling it out for something other than retirement. Now, if you're older than 59, you literally could pull it out, go buy a boat. There's zero penalty on that at all. The gains on it. So interest, dividends, capital gains that needs to stick in the account for five years before you can pull that out without paying taxes on it. So there are some nuanced rules around how and when you can pull money out of the Roth ira. But all things considered, they are remarkably flexible on the timing and purpose of distributions out of the Roth ira. That said, if you don't need it for college and this thing can grow, let's say your child is eight and you contribute $7,000. You let that grow for 40 years. Do you know how big that's going to be? It's going to be probably like 6 or 700. Just that. Maybe not that much, but it's going to be significant. Let me give you an example. I just ran some numbers here, and I'll share my screen here. If you contribute $7,000 for 20 years, let's say you do it, your child is, is five, and you do it until they're 25, you know, graduating from college, whatever. And the current year, $7,000 max contribution to the Roth IRA. But every year that's going to grow up, so go up. So I have it going up by, by 2.5%. Basically inflation every year. And so what is that $7,000 that one contribution turn into in 20 years, it turns into $30,000 at an 8% return. If, if there's a larger return than that, it's going to be more than that. But that one $7,000 contribution turns into $30,000 the next year, you contribute 7,175, that one contribution turns into 28,000. 6, 71. Now contribute, it turns into a little bit less because it has one less year to compound grow. But if you just Contributed the Max IRA Every year for 20 years, at the end of that 20 years, you're going to have almost four, $400,000. Imagine what your child can do at age 25 with 400,000. I mean, maybe don't imagine too hard because they could do some really stupid things with that. That is true. Assuming that you have a responsible child, they could use that as a down payment on a home. They can use it to help fund a wedding. Of course they can use it for college costs. Or they can just let it grow until they are retired. And that $384,000, if you stop there and never funded it again, that will double probably every eight years or so. And so it would go from 400,000, 800,000 to 1.6 million to 3.2 million. It's probably where it would end up, would probably be around 3 million or so by the time they're, you know, 6570. That's more than a lot of dentists have when they retire, period. To put into context the power of deferred growth. And it would be entirely tax free. So they turned 59, they could literally go pull out 100% of it and pay zero in taxes, zero in penalty. Roth IRAs are an absolute beautiful thing and I hope they stick around for a long time. Now that's the beauty of the Roth ira. Now I asked earlier, what would you invest in it? Well, if this is going to be used long term, like 40, 50 years, then I would put high growth stuff, high volatile, high growth stuff like emerging markets for example or small cap for example, or maybe some growth accounts, for example, things that are very volatile. But typically if you have a broad diversified set of investments, maybe you hold 50 different company stock in there from around the world. It's very diversified, it'll be very volatile. Volatility in time produces the highest return. It's just the hardest to stomach. But it will provide the highest return over time. So I love putting things like emerging markets in our Roth IRAs. And we here at practice CFO are very keen to on what's called tax location, meaning if you have a tax free account like a Roth IRA or a Roth 401k or and a tax deferred account like a traditional IRA or traditional 401k or defined benefit plan and you have a tax, a taxable account like a normal brokerage, individual account, trust account, joint account at Vanguard Fidelity, whatever, Merrill lynch, you have these three different types, taxable, tax free, tax deferred, tax free. Certain investments are going to are much better placed in each of those buckets and it depends on your tax bracket as well now and what we forecast it to be in retirement. So there's a whole strategy around which investments go in which accounts. And that is one of the A good investment advisor earns their fee is on that investment. Advisors really earn their fee on good asset allocation, good psychological coaching for clients and good tax placements. A lot of times it's not on the specific securities because they're doing broad asset allocation and probably using ETFs or exchange traded funds or index funds. And that's where advisors can really earn their money is these extra things that so many advisors don't do and tax location is one of them. And we have software here that helps us systematically locate our, our clients investments in the right account, depending on which types of accounts they have in their portfolio. All right, let me get back on track with the ira. If your child is going to use it for school and they're going to school in, you know, five or six years, you want to start to get a little more conservative there. Maybe start adding in some, some bonds or what's called fixed income to reduce the volatility because the last thing you want is right before they start college, the account drops by 50%. You really want to avoid that. So you systematically make it more conservative as time goes on. And you can do sort of what are called target date funds. And normally target date funds are for retirement. And you say I'm going to retire in 2040. And the in that fund automatically becomes more conservative and less volatile as you approach 2040. You can use a target date fund and the target date would be your kid's college start year as a good option there. And then you never have to rebalance it, do any trading. It's just forget about it and it will do its thing. Vanguard's a great option for that. Schwab has some great options for this. There's a lot of really inexpensive options to do that. Now the other option is if you're going to peg this money for education costs exclusively, there are certain benefits to the 529 account. Now that said, my first choice is the Roth IRA because what if they don't need the education money? The Roth Hour can be used for other things. Education, educate, education. 529 accounts have to be used for education costs. That's book to, that's, that's room, board, tuition, books.

It has to be. If it's not, you're going to pay taxes on them when you pull out and you're going to pay a penalty on it of 10%. So 10% plus whatever your tax rate is, it gets very expensive to do that. So here's maybe a good scenario is you fund the 7,000 of the roughly 13,000, 14,000 that's going to hit your account because of your child's payroll of 15,750 after FICA tax, let's say it's 14,000 is left that hits the account. You could take half of that $7,000 and go put in their Roth IRA. The other half, you could go put in a 529 account. Or you could put it 100%, the 529 account. If you think they're going to do expensive private college and maybe go on to a graduate degree and you just really want to beef up their education account. You could put it all in the 529 as well. That's, that's family planning. Also I will mention, incidentally, some doctors are really into their kids clawing and, you know, just really making their own way and paying for their own stuff. Like I paid for 100% of my college costs. And I will say I feel like I took my college very seriously when I knew I was paying for it. And I did everything I could to try to get grants and all that stuff. I really owned it. At the same time, I, for my own kids, I said, hey, I'm going to help take care of your tuition, but I do expect you to either work or get a little bit of a loan to pay for some of the incidentals. And I sort of struck that middle ground because I do want him to feel some of the labor and burden of being a student. And. But that's very much a preference between you and your spouse. If you're married, the parents. And we as financial advisors are here simply to support your philosophy here and give you strategies to do it in the most financial and tax effective manner. Now let's talk about these 529s a little bit longer. A little bit longer.

You know what I'm going to do? I am going to. For lack of time. We are currently at, in this podcast. We are currently at.

44 minutes right now into the podcast. So I'm going to stop this one and do a part two on this Kids on Payroll strategy. Stay tuned for more on this really valuable subject. Until then.