Though they may only have three months off from school, a summer job can teach kids a lot about financial responsibility. Summertime presents a great opportunity for students to earn income, get work experience, and save for the future. Here are some tips for helping your child make the most of a summer job.
Keep an eye on earnings
Since a summer job typically lasts just a few months, it's important to consider ways to help your child keep as much of his or her paycheck as possible. Evaluate the tax situation. In 2013, a dependent doesn't have to pay federal income tax on earnings up to $6,100. Assuming your child has no other income and won't earn more than $6,100, he or she can claim exemption from withholding on Form W-4. This means your child won't have to file a tax return to get withheld taxes back.
Here are some other tax considerations to keep in mind:
- Tips are included in taxable earnings. If your child receives $20 or more in cash tips in any one month, he or she must report those tips to the employer, who will include them in the amount of earnings subject to withholding. The requirement to report tips applies whether total earnings are over or under $6,100, since tips are subject to social security and Medicare tax.
- Self-employment income is taxable. If your child has self-employment income, such as from babysitting or lawn mowing, he or she may owe self-employment tax. The tax applies to net self-employment income of $400 or more.
- Income protection allowance. For 2013–2014, dependent students have an income protection allowance of $6,130. Earnings above $6,130 will be counted toward the expected family contribution (EFC) at a rate of 50 percent. (Earnings through the Federal Work-Study program do not count.)
- Retirement accounts. Money saved in a retirement plan, such as a Roth IRA, is not considered an asset for financial aid purposes. Distributions, however, are considered as income in the financial aid calculation.
- Non-retirement accounts. Money saved in a non-retirement account or in cash by the student will count toward the EFC at a rate of 20 percent.
Encourage your child to maximize the value of his or her paycheck by saving early. Setting aside even a small amount from each check can add up to significant savings for the future. Plus, developing a saving habit now will only benefit your child when he or she starts working full time.
Harness the power of compounding. By saving early, your child can take advantage of compounding interest. Though the rate of return may change year after year, compounding makes it possible to generate earnings from previous earnings. For example, if your child saves $5,000 per year over 3 years starting at age 18, his or her $15,000 may grow to more than $250,000 by age 60, assuming a 7-percent rate of return.
Consider a Roth IRA. Though it may be hard for a teenager to think ahead 50 years, saving early can go a long way toward securing a comfortable retirement lifestyle. If your child has earned income, he or she can contribute to a Roth IRA—an attractive savings vehicle for low-income earners, such as students. With a Roth IRA, your child may not have to pay any taxes today but would be able to take tax-free distributions in the future.
Keep in mind:
- If your child is a minor, he or she may need you to sign on the account.
- The contribution limit in 2013 is the lesser of $5,500 or the amount of earned income.
- If your child needs to take distributions from the Roth IRA before retirement, contributions can come out first, tax- and penalty-free. If your child has held the Roth IRA for five years or more, he or she can withdraw up to $10,000 in earnings, tax- and penalty-free, for the purchase of a first-time home.
Besides offering life experience, a summer job can teach kids valuable lessons in financial responsibility. By keeping these tips in mind, you can help your child pave the way toward a bright financial future.
