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

In this episode of the Dental Boardroom Podcast, host Wes Read, CPA and financial advisor at Practice CFO, dives into one of the most powerful  yet often overlooked  tax and wealth-building strategies for dentists: putting your kids on payroll and using that earned income to fund retirement and education accounts.

Wes explains how hiring your children in your dental practice (for real, legitimate work) creates not only a tax deduction for the practice but also a springboard for long-term wealth accumulation in the child’s name. He emphasizes the Roth IRA as a uniquely flexible and tax-free account, often a better choice than a 529 education account, since the funds can be used for retirement, education, or other qualified purposes.

He walks through how to handle payroll logistics, funding contributions annually to simplify administration, and how compounding growth turns even modest contributions into hundreds of thousands  or even millions  over a lifetime. Along the way, Wes shares investment allocation strategies, including why volatile, high-growth assets fit well in Roth IRAs and how “tax location” across different account types can meaningfully boost after-tax returns.

The episode also compares Roth IRAs with 529 plans, outlining when each makes sense, and highlights the importance of aligning education funding with family philosophy  whether parents fully cover tuition, split costs, or expect children to pay their own way.

This is part one of a two-part series on the Kids on Payroll strategy, with part two focusing more deeply on 529 plans.

Key Points

• Paying your kids from the practice creates a deductible expense and earned income for them.
  
• A Roth IRA for children offers unmatched tax-free growth and flexibility versus 529 accounts.
  
• Funding once a year avoids payroll admin headaches while still capturing the benefit.
  
• Compounding can turn $7,000 annual contributions into millions over decades.
  
• High-growth, volatile assets fit best in Roth accounts due to their tax-free nature.
  
• Tax location (placing the right investments in the right accounts) is a major driver of long-term wealth.
  
• Family philosophy matters  whether parents fully fund education or expect kids to share the cost.

Transcript:

Wes Read:  Everybody to another episode of the Dental Boardroom podcast to 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 gonna 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 gonna get rerouted back in their family pocket. So today we're gonna 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 5 29 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 sending 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. 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. 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, 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 cashflow forecast, a tax analysis, a 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 backend 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 outta 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 gonna be significantly better off because of the decisions made today. That's the nature. 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.

So the main goal here, reduced taxes plus building family wealth and how we can fund our kids Roth IRAs and or five 20 nines and do it in a tax compliant strategy. Now why to do this? We are sh the, 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 a hundred percent 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 eight years old or 18 years old, they're gonna 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 gonna 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 stares. 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 your taxable bracket, if you're married to filing joint and you are in the 700,000, so you're a very strong earner, that next dollar of profit you earn is gonna be taxed at 37% Fed plus your state tax rate.

If you're in California, that's probably gonna be between nine 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 gonna go into a little bit more detail on that as well. And outta 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 paid taxes on, which is what's gonna happen when you put your 12-year-old on your payroll.

And I'm gonna show you how. I'll also talk a little about the rules of five 20 nines 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 5 29 education savings plan. 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 shifting income. Let me explain that. When you pay your child a dollar. It goes through payroll. That dollar is a tax deduction to your practice tax return.

Now, most of you are gonna be set up as an 1120 s 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-P-L-L-C. If you're in California, you're required to be a professional corporation, whether you're an LLC or a professional corporation or A-P-L-L-C or a 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, IE non partnerships, they will file as an S corporation. And as an S corporation, you have expenses, your labor, your labs, your supplies, your facility.

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've been a hundred thousand dollars and then you decide to put your child on payroll and you get 'EM one payroll for a thousand dollars on December 31st, your taxable income is now gonna be $99,000 instead of a hundred thousand dollars.

And if your taxable income is only $99,000, guess what? You're gonna pay lower taxes than on the a hundred thousand dollars. So the question becomes, how much should you pay your children? Here's the strategy, the, your, you could probably pay your child a lot of money, a hundred thousand, 150,000, and they would be in a lower tax bracket than you.

However, the more you pay them, the L, the less the spread between your tax bracket and your kids' tax bracket. If you're in the highest tax bracket, you're gonna be in 37%. If you're in the second highest tax bracket, you're gonna be 35%. Your kids up to a certain amount federally are taxed at the 0% income tax bracket for 2025.

That number is 15,750. 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 route, nothing. That is their total taxable income, 15,750, and they're gonna 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 briefs 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 seven or 8,000, but it goes up every year. This year it's 15,750, so you pay your child 15,007 50. You reduce your taxable income by 15,750 and your child doesn't pay any federal income tax on it because they get a standard deduction for that exact amount of 15,750. So if you end up paying them 20,000, well yeah, then they're gonna 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 10 40 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 10 40 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 five 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, um, 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 in, uh, if it's in a no state tax, uh, state. Um, however, if you're in California, you know the, you may owe, 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 gonna be subject to, uh, 15 uh cents. 15.30 cents is the FICA taxes on that dollar. And then sometimes there's some unemployment tax that might be added, maybe a, 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, uh, your payroll company's gonna remit a little bit of FICA taxes on this pay to your kids, you're gonna 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 15,750, they're, depending on the state, they're probably gonna owe somewhere around 15% on that. 15% on that. So let's, if I pull out my calculator and I say 15, 750 times 0.1. In that case, we're looking at $2,362 in FICA taxes.

You could say, well, actually that's not bad 'cause my child is gonna start getting social security credit very early, which could help later on many, many years later on benefit from social security credits. 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.

Let's say your state is four 4%, so we're gonna say 39% total times 15,750 equals 6,142. Less than roughly 2,200. It's about $4,000. Now there might be a few extra incidental costs. Maybe there's a, 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've 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 wanna do it for each child at the level of the standard deduction for that year, which again, this year is 15,750. And the higher that goes, the more benefit you get from a tax savings standpoint. Okay. Now does your child actually need to be working in the practice? Well, if you're audited, the answer's gonna be yes, because you can't just pay a child with no for, with without any underlying reason, without the IRS saying, wait, that's, that's just a pure tax strategy that has no substance behind it, and we're gonna 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. 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 him come in and do a little bit of cleaning, even if you already have a cleaner. Just teach them 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? 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, uh, 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, this is a modeling fee I pay for, uh, 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. 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, uh, eight 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 to 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.

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 uh, they will not work enough to get benefits like 401k or health benefits.

They won't need that 'cause they're likely on your health plan. Of course. They're not really gonna 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, a hundred, $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, um, roughly around $18,000 such that after the FICA taxes come out, they are getting 15,000.

Uh, 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 checking account. So you could do it once a year, I think if you were 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. Uh, 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. If it's 15,750 and there's 24 pay periods for the year, we will take 15,750 divided by 24, and that's what we will make the payroll for each child.

And then depending on the state, we'll sometimes withhold one 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. Alright, 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 wanna pay a dollar more than the standard deduction. 'cause if you do, then you actually have to file a 10 40 tax return. If you don't, you don't even need to file a 10 40 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 a independent contractor, not independent. Probably better to be a sole proprietor and not a corporation. 'cause corporations have corporate tax fees. There's, um, 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.

You're 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, two 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 a thousand dollars 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, uh, you are parlaying one benefit IE 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 gotta go into the bank, you gotta 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, uh, a certain age, depending on the state. So a little bit of a pain in the butt historically. What I typically recommend is just to have it deposited in the same account that your own direct deposit lands. So your own business, uh, 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 FI taxes, let's say it's $12,000, that's $36,000, $3,000 a month, that's gonna land in your personal checking account because of your kids' 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. Alright? 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 are normally taking home 12,000 from your own payroll in your practice and you're getting now 3000 a month from your kids, I would simply lower yours to 9,000. Your kids', 3000 deposit adds to yours, and now you get two deposits.

Um. 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 at tallies back up to the 12,000 and go and spend on your food, groceries, et cetera, 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 kids' names. So now we're gonna 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 or the custodian, meaning you have the control of that account.

And frankly, most of my clients' kids don't even know the account exists, to be honest. The law is once they reach that age of independence or what's their, the legal term is emancipated. In some states that's gonna be 18. In some states that's gonna 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 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, it, 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.

If you have $15,000 of income, or in this case 15,750 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 15,750 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 Plin goes through their expenses and comes out on the other end.

We pay taxes, debt, personal budgets, et cetera. 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 gotta be my favorite investment account, period. So the money has come into your personal account from your kits.

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, A 15,750. Let's say it's January, 2026, and now you can take the money. You can go and put it in their Roth IRAs. You can set that up if you're with us. We should set that up at Charles Schwab.

You can do it at Vanguard, fidelity, probably prob, probably Robin Hood or you know, any of any bank out there that allows the 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 gonna 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 gonna 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, uh, 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 5 29, uh, 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 gonna get into right now with the one big beautiful bill, the OBBB. Um, 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 gonna 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 a certain age, usually you have to start pulling it out. Right now, that's currently at 72, age 72. You have to take 'em. 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, uh, your kids or whoever you give that to. Regular hours 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 5 29 education account from that standpoint, because if your child doesn't need education co, they don't need support, maybe they have a scholarship, maybe they just come out and under like, you know, killing it in some AI tech and they don't even go to college or they go to a, a junior college for a couple years and they end up not needing that much for their college.

Whatever. 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, uh, pull out for, for anything. Now, a little bit of a caveat on that. If it's before H 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 gonna be a 10% penalty on there because you're pulling it out for something other than retirement. Now, if you're out older than 59, you literally could pull it out, go buy a boat. There's zero penalty on that, uh, 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 gonna be? It's gonna be probably like six or 700 that just that. Maybe not that much, but it's gonna be significant. Lemme give you an example.

I just ran some numbers here and I'll, you know, 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 gonna grow up.

So go up. So I have it going up. By 2.5% basically inflation every year. And so what is that $7,000? That one contribution turned into in 20 years, it turns into $30,000 at an 8% return. If, if there's a larger return than that, it's gonna 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 28,671. Contribute. It turns into a little bit less 'cause 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 gonna have almost $400,000. Imagine what your child can do at age 25 with 400,000.

I mean, maybe don't imagine two 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, 65, 70. 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 a hundred percent of it and pay zero.

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 T ira. Now, I asked earlier, what would you invest in it? Well, if this is gonna 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, uh, 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 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 a 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, certain investments are gonna, are, are much better placed in each of those buckets. And it depends on your tax bracket as well now and what we forecasted 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 feet 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. 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 client's investments in the right account depending on which types of accounts they have in their portfolio. Alright, lemme get back on track. With the ira, if your child is gonna use it for school and they're gonna school in, you know, five or six years, you wanna 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. 'cause the last thing you want is right before they start college, the account drops by 50%. You really wanna avoid that. So you systematically make it more conservative as time goes on and you can do sort of what I call target date funds.

And normally target date funds are for retirement. And you say, I'm gonna 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 5 29 account.

Now that said, my first choice is the Roth ira because what if they don't need the education money? The Roth IRA can be used for other things. Educate education. 5 29 accounts have to be used for education costs. That's book, that's, that's room board, tuition, books. Um. It has to be. If it's not, you're gonna pay taxes on it.

When you pull out and you're gonna 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 gonna hit your account because of your child's payroll of 15,750. After FI attacks, 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 the Roth ira and the other half you could go put in a 5 29 account, or you could put in a hundred percent in the 5 29 account. If you think they're gonna do an 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 5 29 as well.

That's, that's family planning. Also, I will mention incidentally, some doctors are really into their kids clawing and, and you know. Just really making their own way and paying for their own stuff. Like I paid for a hundred percent 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, I really owned it. I the same time, uh, I, for my own. I said, Hey, I'm gonna 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 fill 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, uh, the parents and, uh, 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 five 20 nines a little bit longer, a little bit longer.

Um, you know what I'm gonna do? I'm 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 gonna 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.