Teen Can Have IRA, but There Are Drawbacks

Q: I recently read about children opening individual retirement accounts. The point of the article was that by starting their retirement savings during their teen-age years, kids could take advantage of the tremendous tax-deferred compounding their savings would generate over 50 or so years.

Can teen-agers establish IRAs with their earnings from part-time jobs? Are there any special problems or circumstances we should be aware of if we urge our kids to do this? --H. B. B.

A: Assuming that the teen-agers meet all the Internal Revenue Service’s other guidelines for establishing an IRA, they should face no special obstacles opening an IRA before graduating from school or joining the work force on a full-time basis.

However, anyone who opens an IRA should be well aware of the tremendous penalties the government imposes for early withdrawal of its funds. Not only are funds withdrawn before age 59 1/2 subject to full state and federal income taxes, the federal government imposes a 10% penalty on the amount withdrawn.

It is especially important for any young person to seriously consider the impact of this penalty before deciding whether he is truly in a position to set aside what should be considered virtually untouchable money for the next 40 to 50 years.

Basically the government allows anyone with reportable earned income to establish an IRA. Single taxpayers who are not covered by a pension plan on the job or who earn less than $25,000 per year may set aside up to $2,000 per year in a tax-sheltered IRA. This contribution is deductible from the taxpayer’s earned income and generates tax-deferred interest as long as it stays in the IRA. IRAs can be opened at banks, savings and loans, mutual funds, stock brokerages or any other institution providing IRA custodial or trustee services.

Clearly, given the “magic” of interest compounding, an IRA held for 40 or more years can generate terrific tax-deferred earnings. But before you counsel your teen-ager into such an arrangement, be sure he really has no more important use for that money than to save for his retirement. Given their choice, I suspect most teens wouldn’t rank retirement saving a high priority. Buying a car, yes. Saving for college, perhaps. Even a far-sighted teen probably can’t imagine himself buying his first house.

Perhaps a better deal for a teen with money to invest would be traditional U.S. Savings Bonds, which are excluded from federal taxes and impose no penalty for an early cash-out.

Think Before Putting Child’s Name on Deed

Q: My wife and I are elderly and in ill health. We would like to add our daughter’s name as an owner of our home. How do I do this? Will it increase our property tax assessment? Should I use my daughter’s married or maiden name? --H. D. W.

A: Your property tax assessment will not change if you add your daughter as a joint tenant owner on the deed to your home. The home’s property tax assessment also will not change when your daughter inherits the house at your death if she files the proper forms with the county assessor’s office to claim the exemption for residence transfers between parent and child.

To add your daughter to your deed, simply file a new deed with your county recorder’s office. Your daughter should use her legal name; whether that is her married or maiden name is immaterial. What is important is that it be the name that she is legally known by.

Are you adding your daughter to your deed to allow your estate to bypass probate and go directly to her? If so, your strategy will work. But you should also know that parents who add an adult child as a co-owner of their home potentially expose themselves to serious problems. Once a child is listed as a co-owner of your home, your home is attachable as the child’s asset should he be sued. Furthermore, if the child died before his parents, the parents would have to prove to the IRS that the home should not be included in the child’s estate since the child did not buy or maintain it.

Stock Gift Value Hinges on if Donor Is Alive

Q: I bet you must have received more than 100 letters about your July 12 column item. Don’t you know that the value of stock given as a gift is set as of the day the person received it--not what the donor paid for it? --R. H. M.

A: Actually, the mail bag contained only two letters on the subject. But it was enough to let me know that some people still don’t understand the difference between how to value gifts made in life and gifts made at death.

The tax basis value of a gift made by a living person is the donor’s purchase price of that asset. But the tax basis of an inherited asset--or a gift made at the death of the donor--is set as of the donor’s date of death.

So, if a mother buys 100 shares of a stock for $10 each and gives them to her son five years later when they are trading for $20, the son’s tax basis in those shares is her $1,000 cost.

However, if those same shares were bequeathed to the son upon the mother’s death, when the stock was trading for $20 each, the son’s tax basis would be $2,000. It’s all a question of whether the gift was made in life or at death.