Small distribution from Roth 401K: Earned or Unearned Income - Kiddie Tax Consequences

There are banks that will let you start a Roth with as little as $100. Why not just roll it over and avoid the complexities?

snipped-for-privacy@yahoo.com wrote: : Daughter is 21. She worked a summer job and contributed to a Roth 401K because it had company matching. The total balance at the end of the summer is $600 which is too small for the minimum investment. They want to distribute the proceeds either in a check or in a rollover into a Roth IRA.

: I am trying to evaluate the choice of either 1) cashing the check and paying the taxes and penalty, or 2) adding $400 and rolling it into a Roth IRA account.

: Frankly in the scheme of things, it really doesn't matter. It's a tiny amount of money.

: However, this is a good opportunity to teach her about taxes and the benefits of tax deferral, so I want to get my information right.

: Understanding that she will pay a 10% tax penalty on top of any tax if she takes the cash, if she's my dependent will the kiddie tax apply (she will be taxed at my high rate), or is this earned income so that her own rate applies which is very low.

: I want to explain the consequences of a cash out and let her decide. I want the math to be right.

Not somuch a tax answer, but a good thing for the illustration of compounding. If she starts at 21 with $1,000 in her IRA acound, it will grow, over her lifetime quite nicelyand the account wil be there ready for her to add to as she continues to work. I had a regular IRA (rothe didn't exist then)account I started when I had a short term job and it has been giving me a couple of thousand a year since I turned 70 1/2.

Wendy Baker

I agree with the poster who said that stressing the effect of compounding is the best approach. Calculate what even that $600 will be worth when she's 60 even if she never contributes another dime.

Her contribution has already been taxed, so no matter what she does there will be no additional tax or penalty on that amount. The earnings (probably negligible given the short time) are taxable income and subject to the 10% penalty. The employer match is taxable income if you roll it into a Roth account. There is no penalty. The match is subject to the 10% penalty if she doesn't roll it over. She could roll the match and earnings on it into a traditional IRA with no tax consequence.

Anything that is taxable is investment income subject to the Kiddie Tax rules.

Phil Marti VITA/TCE Volunteer Clarksburg, MD

Form 8814 to report your child's income cannot be filed as that form can only be used if there is interest/dividend/capital-gain income. So they must file their own return where they will get a small standard deduction and the income will be regular income.

Sorry, I checked the form instructions, and form 8814 can only be used if there is interest/dividend income.