Roth IRAs and Your Loved Ones: Planning for the Financial Future of Your Child or Grandchild


15 Sep Roth IRAs and Your Loved Ones: Planning for the Financial Future of Your Child or Grandchild

By Daniel C. Andersen, CFP®

When planning for the future of your child or grandchild, you can draw on several intelligent strategies that utilize Roth IRAs. From college to home purchases to retirement, we touch on strategies you might consider below.

Gifting and Retirement Funding

If you are considering giving a financial gift to your child or grandchild, then you may want to seriously consider funding a Roth IRA for your loved one. First of all, let’s assume that your child or grandchild has earned income and that your gift is less than or equal to their earned income amount. The earned income could be from a traditional job or something else like babysitting or chopping firewood. The long-term benefits of your gift to your child or grandchild will be magnified because of the potential for market growth and tax treatment of money in Roth IRAs.

Let’s assume that you give $1,000 per year to a 5-year-old until they turn 15 and that the market grows at around 9% per year. In total, you have given $10,000, but with market appreciation, the amount can grow to much more. At age 20, they would have over $23,000. At age 65, they would have over $1,100,000 completely tax-free!

Your child or grandchild will have the option of using all or a portion of the funds for college, a first-time home purchase and/or a nice supplement to their retirement.

College Planning

Most people have a basic familiarity with 529 plans as a tool for saving for college, but few are aware of the benefits of utilizing a Roth IRA for the same goal. You can’t contribute as much to a Roth IRA ($5,500 in 2016, $6,500 if you’re age 50 or older) as you can a 529, but a Roth IRA has some distinct advantages.

The funds to pay for college can come from more than just the student’s Roth IRA. The distributions can also come from Roth IRAs belonging to a parent, grandparent or the student’s spouse. If you, the parent or grandparent, elect to use the funds from your own account, you can do so without the normal 10% withdrawal penalty associated with premature distributions of earnings as long as you have had the account for five years or more. If the student doesn’t use all the funds in your Roth IRA, the remainder can be used to fund your own retirement. In a 529 plan, those funds not used for education will be assessed a 10% penalty when withdrawn for non-education-related expenses.

Unlike a 529 plan, neither funds in the student’s nor parent/grandparent’s Roth IRA should adversely affect the student’s financial aid eligibility when filling out the Free Application for Federal Student Aid (FAFSA). Although the account itself won’t affect your student’s eligibility for financial aid, it is important to note that any money pulled out of the account and used to pay for school will count as income to the student on their application in the following year.

Whether from your account or the student’s, you can withdraw the original contribution amount at any time without paying any tax or penalty. For example: If you contribute $5,000 each year for 10 years and the account has grown to $75,000, you can withdraw up to $50,000 worth of original contributions at any time and for any reason. The remaining $25,000 is considered earnings and, among other options, can be withdrawn for education purposes or remain in the account for the account holder’s own use during retirement. If the earnings portion of the account is withdrawn for education purposes, it may be taxable, so make sure to consult with your tax professional.

First-Time Home Purchase

Similar to the college planning section above, funds from a Roth IRA receive preferential treatment when a first-time home buyer uses them to pay for a house. If your child or grandchild has not owned a house within the last three years, then they may qualify as a first-time home buyer. In addition to being able to withdraw your contributions to their Roth IRA or their own contributions to the account, they can withdraw up to $10,000 to go toward their home purchase. For example, if you or they contribute $5,000 each year for 10 years and their account has grown to $75,000, they can withdraw the $50,000 worth of original contributions at any time and for any reason. In addition to the $50,000, they can also withdraw an additional $10,000 for a total of $60,000 tax- and penalty-free to use toward their home purchase.

Parkshore Wealth Management is a family-owned, independent, fee-only Registered Investment Advisor serving the greater Sacramento area with an office in Roseville, CA. We partner with financially responsible individuals and families who are eager to take positive steps that will allow them to use their money to build the life they desire. The firm is led by Harold Anderson, CFP®, and Daniel Andersen, CFP®, both members of NAPFA, the country’s leading professional association of fee-only financial advisors.


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