Q. Can you transfer funds from a Roth to a grandchild within the first five years? H.K., Oakland, N.J.
A. Yes, there is no restriction on such a transfer. As far as taxes go, distributions of Roth account earnings made within five years of creating a Roth are generally subject to federal income tax at ordinary income rates, even if the distributions are made after age 59½. However, under the special IRS “ordering rules,” Roth payouts are taxes as first coming from contributions, then from conversions and finally from earnings. Therefore, there’s a good chance that the transfer will be mostly or even completely tax-free.
Tip: Unless the grandchild needs the money, you could name him or her as a Roth IRA beneficiary to benefit from continued tax deferral.