It’s very common for business owners to employ their children. In fact, there’s plenty of tax planning reasons to do so.
But many clients wonder if their children are required to be included in their cash balance plan. Some want them included them and some don’t.
In this article, will discuss the cash balance plan rules for children. We will explain to you when it’s beneficial to include them and when it’s makes sense to exclude them. Let’s get started!
Employing children in your business
Many people issue W2s to their children. While many of these children are minors, some are earning part-time income in their college years.
You can take a tax deduction for the W2 compensation paid to children. If the total compensation is below approximately $14,000, the children do not have to file a federal tax return (make sure to check with your state).
Not only does it give them some spending money along with workforce experience, but it also allows you to make a Roth IRA contribution for them. So, there are plenty of tax reasons why it makes sense to employ your children in your business.
Do I have to include my children in my cash balance plan?
As a general rule, your children would be excluded from your retirement plans. This is because the plans will specifically restrict participation to those that are at least age 21 and who work more than 1,000 hours annually.
The 1,000-hour rule equates to approximately 20 hours a week. In most situations, children are not working this many hours. So, you are safe to exclude them.
But what if you want to include your children in your cash balance plan? You likely can. But you’ll have to think closely about it.
The age 21 and the 1,000-hour rules are restrictive thresholds that are allowed by the IRS. But you don’t have to have these restrictions. In fact, you could make plan contributions much more liberal. You can open them up to any employee at any age upon the first hour worked.
This might make sense when you and your children are the only employees. But remember, if you decide to hire someone in the future (no matter the age or W2 compensation), you will have to include them in the plan.
You might not be thinking of this today, but several years down the road you might decide to get some part-time help and unfortunately find out that they have to be included. You could find yourself in a difficult situation.
How much can I contribute for my children?
Remember that cash balance plan contributions are largely driven by age and compensation. So, the older you are and the higher your W2 earnings, the more you can get into a plan.
If your children are young and have lower compensation, then a contribution to a plan would be minimal. For example, let’s assume you employed your 15-year-old child and paid them $10,000 a year.
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Because of their young age, you might be only able to get $300 a year into the cash balance plan for them. But the participant fee we would charge you would be $200. Does this make economic sense? I don’t think so.
Getting kids into a plan for the 40% rule
There are some situations where it might make sense to include your children in a cash balance plan. Cash balance plans require you to include 40% of eligible employees in the plan. So if you had several employees, it could make sense to include your children in the plan to meet the 40% rule. That way, the cash balance plan would only be for the family members.
But that won’t get you around the testing rules. You’ll still have to likely make contributions to a profit-sharing plan for the other employees. But it could make some sense for testing purposes, even though it might not work based on preliminary economics.
Final thoughts
It’s quite common for business owners to hire their children, and there are several tax planning benefits associated with this decision. But do you have to include your children in your cash balance plan?
As you can see, it might be beneficial to include them in the plan. However, in most situations it is better to exclude them.
