How do I start a retirement account for a 2 year old?

[Guest Nicolasa MMH]

My 63 year old mother would like to give $1000 to my 2 year old daughter for the express purpose of my daughter's retirement. It is my understanding that a Roth IRA cannot be opened for an individual until after age 14. Hence, would the most beneficial way to give this money to my daughter for this purpose be opening a Roth IRA in my mother's name (she does not have an IRA of any kind of her own) and making my daughter the beneficiary of this account? I know after my mother's death, my daughter would have to take minimum distributions, but they would be tiny if anything by then because of my daughter's life expectancy and at that point, wouldn't it be possible to switch the money over to my daughter's own Roth IRA when she turns 14 if she is not already 14 when my mother passes away? I'm just trying to find the best way to keep this money, tax-free, for my daughter's retirement while earning interest, dividends, etc. over the next 63+ years. Thanks! (nicolemmh@aol.com)

[Alf]

There is no point in going through the hassle of dealing with the minimum distribution rules, plus you never want money to be in a kids name. The theory that I ALWAYS hear explained is that the kid can take it at age 18 and blow it on anything. College money or retirement money should be kept in the name of a responsible adult who can give the money to the kid once the kid has proven that she is responsible.

[Mary Kay Foss]

Your mother cannot open a Roth IRA unless she is working. She needs as much earned income as the Roth contribution.

A Roth IRA cannot be rolled over into a Roth for anyone but a surviving spouse. A beneficiary is required to take distributions after the owner's death but as Alf pointed out there are problems with a minor as beneficiary.

The beneficiary can only take over at the death of the owner, attaining age 14 does not allow a change in the ownership or income stream.

Why does she want to provide for retirement? Most grandparents are worried about college funding.

[John G]

I have never seen any Federal rules governing a "legal" age for an IRA, what most people thing are IRS rules are in fact custodian specifications. For example, Etrade wants all IRA owners to be 18 while Charles Schwab places no such restrictions on children but has a parent custodial setup.

The key requirement is to have earned income. A two year old child could have earned income if the child was a advertising model, but I would have a hard time accepting any other kind of work. A 12 year old can deliver papers, baby sit, clean cars.... so earned income is a possibility.

Three suggestions: (1) the grandmother may want to consider the college investment options run by states and some brokerages like Fidelity, and wait for IRA eligibility, or (2) consider a tax managed mutual fund or index fund where the annual tax implications are zero or near zero and eventually distributions will be taxed as long term capital gains, and (3) split the $1000 into two parts and fund an educational IRA for the child [current max is $500 per year] half this year and half next year.

Money in a child name is a bad idea? I have an alternative view. Willful kids who will want to "blow it" when they are 18 are something of a boogie man and assumes parents have no impact of the morality and common sense of children. Yes there are bad apples, but the frequency is low. A second negative is that money in a childs name counts more heavily in college financial aide calculations that money kept by parents. On the positive side, teaching children about saving and investing may help counter the credit card culture of spend and spend.