Seed a Roth IRA for Your Grandkids

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As summer approaches, teenagers and college students are usually busy planning for summer jobs. And the income they earn gives grandparents an opportunity to help the youngsters build a nest egg by contributing to a Roth IRA on the grandkids' behalf.

Contributions to Roth IRAs give grandchildren "a huge head start," says Jennifer Failla, a certified financial planner with Strada Wealth Management, in Austin, Tex. Grandchildren can later tap the accounts for expenses such as buying a home or, ideally, use them to build tax-free retirement income.

You'll also be teaching your grandchild the value of saving from a young age, says Ajay Kaisth, principal with KAI Advisors, in Princeton Junction, N.J. For example, if you contribute $2,000 a year over four years starting when your grandchild is 15, assuming a 6% annual rate of return, the contributions will grow to more than $143,000 by the time the grandchild turns 66.

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Your grandchild must have earned income to be able to contribute to a Roth IRA, and the contribution can't be more than they earned during the year, or the maximum of $5,500 (the IRS’s cap for 2017), whichever is less. You can put the money into the account for your grandchild, while the grandchild keeps his or her earnings. Here's an example: Your grandchild earns $3,500 from a summer job, but she uses it toward buying a car. If you give $3,500 to the grandchild, that money can be contributed to the Roth IRA.

Your contribution will be considered a gift to the child, so be sure to coordinate it with your other gifts for the year. Each grandparent can give a total of $14,000 per year per person without having to file a gift-tax return, or $28,000 total to one person from both grandparents, says Adam Zuercher, wealth manager at Hixon Zuercher Capital Management, in Findlay, Ohio.

You can prefund an account, but if your grandchild's job falls through or he earns less than expected, you’ll need to make sure the excess contribution and its earnings are withdrawn from the account before the next tax-filing deadline, Zuercher says.

You maintain control of the money until the grandchild turns 18 or 21, depending on the state. Then the grandchild can use it however she wishes.

Mary Kane is a financial writer and editor who has specialized in covering fringe financial services, such as payday loans and prepaid debit cards. She has written or edited for Reuters, the Washington Post, BillMoyers.com, MSNBC, Scripps Media Center, and more. She also was an Alicia Patterson Fellow, focusing on consumer finance and financial literacy, and a national correspondent for Newhouse Newspapers in Washington, DC. She covered the subprime mortgage crisis for the pathbreaking online site The Washington Independent, and later served as its editor. She is a two-time winner of the Excellence in Financial Journalism Awards sponsored by the New York State Society of Certified Public Accountants. She also is an adjunct professor at Johns Hopkins University, where she teaches a course on journalism and publishing in the digital age. She came to Kiplinger in March 2017.