Building Your Child’s or Granchild’s IRA

By Marvin Rotenberg, IRA Technical Expert

We have previously written about a “lack of financial literacy,” indicating that many individuals don’t know or understand the benefits of IRAs or saving for retirement.

One of the best ways you can help your children or grandchildren learn about investing for their future is to share your own experience. You know the value of a good retirement nest egg (especially if you are reading this website each day), but kids just don’t think of those things. You probably didn’t either when you were younger.  By sharing your experience, by having your child or grandchild start saving early, and by making it fun, they will see the value. (Editor’s Note: Ed Slott’s new book, Fund Your Future, talks about just this and provides a detailed plan to get you there. You can pre-order the book here).

You can begin by telling your children about the value of preparing for retirement by making wise investments through a traditional or Roth IRA. A Roth IRA is particularly well-suited for younger individuals. Children or grandchildren are not interested in, or need, an income tax deduction for a contribution to an IRA. A Roth IRA has the ability to grow over the years on a tax-free basis rather than tax-deferred basis.

As your children or grandchildren mature and are able to understand some of the basics of investing, explain what you have done to grow your own IRA wealth. Your flourishing retirement account may be the best means of teaching your kids the value of smart investing and spurring them to build their own nest egg.

An IRA contribution must be based on the taxable compensation (earned income) of the individual for the year of the contribution. Compensation is income received for personal services rendered. Passive income, such as income from investments, is not considered for the purpose of making an IRA contribution. You can use this chart to see the 2012 IRA contribution limits.

If your child or grandchild has a paper route or another part-time job, that money can be claimed as earned income. In these cases, you can even make monetary gifts to them, up to the amount they have earned during the year, to help them fund their IRAs. Then, for each one, using their Social Security number, open an IRA in their name, designate an appropriate beneficiary, and start watching it grow. Yes, they may be young, but each IRA owner should always have a beneficiary. Follow this beneficiary form checklist.

The maximum contribution for 2012 is $5,000 assuming they earned that much or more. Not every IRA custodian will establish an IRA for a minor, so you may have to do a little leg work to find one. You and your progeny will be glad you did.