Put a Student on the Path to Retirement Without Hurting Financial Aid

Question: My grandson had a job last summer, and I think it would be a good idea for him to open up a Roth IRA. Can I give him the money to contribute, and how will it affect his chances for financial aid for college?

Answer: Children of any age can contribute to a Roth IRA as long as they earned income from a job. (If your grandson is a minor—under age 18 or 21, depending on the state—he may need a custodial Roth IRA opened for him by an adult.) Because your grandson worked last summer, he has until April 17, 2018, to contribute to a Roth for 2017. He can contribute up to the amount of money he earned last year or $5,500, whichever is less. As long as he had eligible income, you can give him the money to contribute.

This is a great way to give him a head start on retirement savings, and he can withdraw the contributions without penalties or taxes at any time. You need to time your gift carefully to minimize the impact on financial aid. Money you give him to contribute to an IRA is considered to be student income in the year it’s received, and student income is hit hard by the federal financial aid calculations. Students are allowed to earn about $6,570 a year without it counting in aid calculations. But for every $1 students earn above that limit, they are expected to contribute 50 cents toward college costs.

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The Free Application for Federal Student Aid (FAFSA), which families must fill out to receive aid, now looks back at earlier tax returns to report income and assets. For example, the FAFSA for the 2018-19 academic year uses 2016 tax figures. That means money you give your grandson before January 1 of his sophomore year of high school won’t be included as income on the financial aid application.

Retirement accounts are sheltered assets on the FAFSA, so once the money is in his Roth IRA, it won’t affect his aid eligibility as long as he doesn’t make any withdrawals. If he does take money out of the Roth during the tax years under review by the aid formula, however, it’s considered to be student income in aid calculations—even if some of the withdrawal is from contributions and isn’t taxable. So he’ll want to wait until after the last tax year that counts for financial aid before withdrawing any money from the Roth.

For more information about the benefits of opening a Roth IRA for a kid, and a few IRA administrators that make it easy for minors to open an account and charge low or no fees to get started, see Roth IRAs Are for Kids, Too.