A Roth IRA for a grandchild

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Q. I’m thinking of saving for my grandson who is 14. I’m not sure what his parents have saved for college, but I’m also thinking of doing a Roth IRA for him. What do you think?
— Grandpa

A. Your grandson is lucky to have you.

A Roth IRA can be a tremendous tax-advantaged vehicle to use for retirement, and it has other benefits, too.

If you could help your grandson start a Roth IRA when he is young, it could really give him a solid head start for his future.

To qualify, your grandson must have enough earned income — defined as income received from working — to cover your contributions, said Michael Cocco, a certified financial planner with AXA Advisors in Nutley.

He said you can make the contribution, but your grandson needs the earned income to qualify for the Roth.

Gifts and investment income do not count.

Cocco said earned income can come from working in a family business and being on payroll as a legitimate employee, or earning money shoveling snow, or doing other odd jobs or side work where he receives actual taxable income.

If you’re considering adding him to the payroll of a family business, be sure to consult with a CPA or tax advisor first, Cocco said, to be sure all the guidelines are followed.

Under current law, the Roth IRA will allow your grandson to accumulate money on a tax-free basis and if he waits until age 59 ½ to make withdrawals, these would be 100 percent tax-free upon distribution.

But, Cocco said, there could also be some benefits before he reaches retirement age.

“He would be allowed to withdraw his principal first without any interest or penalty at any time; and could allow the earnings portion to stay in the account until age 59 ½, when those monies would be able to be accessed tax-free,” Cocco said. “Also, money held in a Roth IRA would not be considered a countable asset when qualifying for financial aid when he’s ready for college, according to the FAFSA form.”

He could also use the account to help fund college, but the distributions from the Roth IRA would need to be disclosed and could reduce the amount of financial aid he might qualify for, Cocco said.

Because your grandson is under the age of majority, Cocco recommends opening up a custodial Roth IRA, for which you could be the custodian and make the investment decisions for his account. Many brokerage firms allow for these types of accounts, and there may be additional gift or tax considerations, so speak with your financial and tax professionals to be sure you execute this properly, Cocco said.

“Aside from the financial benefits of helping your grandson set up a Roth IRA, it will expose him to the world of savings and investing, teaching him good habits from the start,” he said. “This sort of benefit could shape his attitude towards `paying yourself first,’ which will have far-reaching benefits beyond the money you put aside.”

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This story was first published in May 2017.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.