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Four Ways to Celebrate the Golden Years

It's that time of the year again. How to help the Grayest Generation provide a healthy financial future for their grandchildren

I don't need to tell you that national Grandparents Day falls on Sept. 10 this year. As usual, the festivities will start early in the morning and continue to early in the evening (assuming the celebrants get a brief nap in after lunch).

Never heard of Grandparents Day? Well, it's a real holiday, and you shouldn't be surprised that the proclamation establishing the holiday, which always falls on the first Sunday after Labor Day, was signed by Jimmy Carter in 1978.

OK, so the notion of honoring these beloved senior family members barely rivals the excitement brought on by Arbor Day. But the holiday will at least give you a reason to call your clients who help make up the Grayest Generation and let them know how they can help their grandchildren. Here are some ideas that will whet a grandparent's appetite almost as much as a dollar-off discount at the early-bird buffet:

  1. Open a Roth IRA — for the kid

    If your client's grandchild was one of the four million teens who had a job this past summer, the grandparent can open a Roth IRA for the child. Your client can even make the deposit, although the money then becomes an irretrievable gift to the child.

    Since many schools don't count money in a child's retirement account as assets that can be used to pay for college, putting money into a kid's Roth IRA usually won't reduce any potential financial-aid award. Yet that doesn't mean the money is off-limits for future college expenses. What your client doesn't know (but you surely do) is that contributions to a Roth IRA can be withdrawn at any time, for any reason, with no taxes or penalties whatsoever. So, in a pinch, whatever has gone into the account can be pulled back out with little or no friction.

    But if the child can keep her hands off the money, there's a big payoff down the road. Assume $4,000 contributions are made to a child's Roth IRA during each of her four years of high school, and the money earns a hypothetical 8 percent annually. By the time the grandchild is 68, the $16,000 put in would be worth over $1 million — tax-free.

  2. IRA stands for “Instant Retirement Account”

    The drawback to considering an IRA or Roth IRA for a child is that the kid has to have earned income upon which to base contributions to the retirement accounts. For a client with a grandchild who is either too young or too, um, laid-back to have a job, another solution exists: deposit money into a tax-deferred variable annuity for the child.

    This strategy is especially appealing to retired grandparents, many of whom are concerned that Social Security won't be around when their grandchildren retire. For the cost of a few monthly checks, your client can ensure his grandchild's golden years are untarnished; $5,000 deposited for a newborn baby today will be worth a cool million when the kid is 66 — if the account nets 8 percent per year.

    A couple of caveats: First, keep a keen eye on expenses in the annuity. In the scenario above, reducing the grandchild's net return by just a half-percent per year turns the million-dollars-at-66 into just a little over $700,000. Second, make sure the client knows that money taken out of the account before the kid turns 59 1/2 will be hit with both taxes and penalties (although this pain may help to prevent an impulsive child from tapping the account before the grandparent's intended goals are realized).

  3. Familiarize them with 529s

    With a total of $70 billion invested in over seven million 529 accounts, it would seem that telling grandparents about college savings plans is an idea that has, uh, matured. But these numbers also reveal that nine out of 10 American children under the age of 18 don't have a 529 opened for their benefit.

    Here are the particular features of 529s that will be especially appealing to a benevolent grandparent:

    • Control — If the grandchild doesn't need/want/deserve the money for college, the grandparent can transfer the account to another member of the family — or eventually liquidate it himself (with taxes and small penalties due on the “earnings” portion of the account).

    • Tax breaks — Depositing money in a 529 will defer taxation on future earnings, eliminate it altogether if the money is used for qualified expenses and could reduce the heirs' eventual estate tax bill, too.

    • Favorable financial-aid treatment — Although each school is free to use its own method, the most widely used procedure to determine need-based aid is the federal financial-aid formula — in which college savings plans owned by grandparents will not hurt the packages offered.

  4. Make the grandchild an IRA beneficiary

    It will cost your client little in the way of time, money or commitment. But putting the grandchild's name down as the inheritor of Grandpa's retirement account could provide a lifelong tax-advantaged financial safety net for the lucky little tyke.

When your client dies, money in retirement accounts must, of course, be withdrawn at least as fast as the beneficiary's life expectancy dictates (as calculated by the IRS in Publication 590). The younger the beneficiary, the less the IRS requires to be withdrawn, leaving more to accumulate sheltered from taxation.

The advantage of leaving an IRA account to a grandchild instead of an adult child can be astounding. Say a 65-year old dies today, leaving his 40-year-old daughter a $100,000 IRA. If the money earns 8 percent per year and the daughter only takes the required minimum distribution each year, she'll get about $940,000 over the next 43 years.

Not too shabby — until you consider an alternate scenario in which the daughter's five-year-old son gets the account. Using the same rate of return and only taking the required minimum distribution annually, the fortunate grandson would get $7.7 million over the next 77 years.

Since your clients can change the beneficiary designation at any time without notifying their children or grandchildren, this strategy is especially cherished by grandparents who prefer to have financial details revealed postmortem.

Writer's BIO: Kevin McKinley is a CFP and vice president of investments at a regional brokerage and author of Make Your Kid a Millionaire — 11 Easy Ways Anyone Can Secure a Child's Financial Future.

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