04 Dec Opening a Roth IRA for my grandchildren

 Q. Would it be wise to start a Roth IRA for my grandchildren, and how much would it take to open one? I used to buy them I-Bonds every Christmas but can’t rely on that anymore. Please advise, or would you suggest something else other than a 529 Plan?

A. Your grandchildren are lucky to have you.

Deciding what kind of investment is best for your grandchildren depends on what financial goal you are hoping to accomplish, and when your grandchildren will need the money.

If you wish to jump start their retirement planning, a Roth IRA can be a great idea, said Jody D’Agostini, a certified financial planner with AXA Advisors/The Falcon Financial Group in Morristown.

“The Roth IRA allows you to contribute after-tax money, which will grow income tax-free and be able to distribute income tax-free in retirement, or after they are 59 ½ years of age,” she said.

But the maximum contribution is limited by the earned income amount your grandchild has for that calendar year. D’Agostini said the upper limit would be $5,500 for 2014, assuming that he or she has earned that much.

But the difficulty may be that once the grandchild has reached the age of majority, which is age 18 for most states, they will retain control of the account and may use the money any way that they choose, she said.

Learn more about using an IRA to pay for college.

“If you started a traditional IRA instead of a Roth, there may be less desire for them to invade it, as there will be taxes and a 10 penalty for early withdrawal,” she said.

In order to have earned income, your grandchild must have a job that pays him or her wages. If they receive a W-2, then you need no further proof. If, however, they do jobs such as babysitting, mowing lawns, paper delivery and the like, they will need to keep receipts and file a tax return to prove income, she said.

D’Agostini said Roth IRAs are not taxed upon withdrawal for any qualified distribution, which is defined as disability, reaching the age of 59 ½, taking money as a first-time home buyer or for qualified higher-education expenses.

If you withdraw for any other reason, you will incur a 10 percent tax penalty on the earnings or interest from your contribution. Also, you must wait at least five years before withdrawing money from a Roth or you’ll incur that 10 percent penalty, she said.

Now, about your goals for the money.

If the funds are not for college, and if it’s not for one of the “qualified distributions,” you might consider a gift to a Uniform Transfer to Minor account, or UTMA, D’Agostini said.

“This account would allow you to be the guardian until the grandchild reaches the age of majority — 18 in New Jersey,” she said.

You could gift up to $14,000 a year with no tax, or $28,000 if the gift is from you and your spouse.

In UTMAs, the child is taxed at their lower rate for the first $2,000 of unearned income, which is interest, dividends and capital gains. Above that, the income would be taxed at the parent’s highest tax rate, she said.

Even though you didn’t sound too hot on using a 529 Plan, that may be a good option for you, said Devang Patel, a certified financial planner with MetLife Premier Client Group in Cranford.

“In a 529 plan, you control the account, its proceeds grow tax-deferred and the growth is tax-free as long it is used for college or other qualified expenses — consult your tax advisor for the exact specifics as they apply to your situation,” he said.

Another benefit is that you can transfer the proceeds of the 529 plan to other grandchildren, in case the grandchild for whom you set up the account chooses not to go to college or does not need it, Patel said.

You can also change investment options to make sure the account has age-appropriate investments depending on the account beneficiary.

Good luck in making your choice!

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This story was first posted in December 2014.