A grandchild's most important financial adviser

The most influential financial advisor to young adults may not be the one they hire.

Recently I sat down with Joe Coughlin, director of the AgeLab at the Massachusetts Institute of Technology, and we discussed the findings of a recent survey he did with TIAA-CREF. According to the survey findings, young adults actually want advice from their grandparents to help guide their own financial decisions.

The research shows that while only 10 percent of grandparents think they can help influence their grandchildren's financial decisions, about 73 percent of young adults believe their grandparents can offer them valuable advice.

The financial wisdom grandparents often pass along can be boiled down to this: Always spend less than you earn, save plenty, invest wisely and give generously. These principles are timeless.

Grandparents can be good financial role models for their grandchildren because they've moved past the "accumulation of stuff" phase in life and likely live on a fixed income. Making savings last and spending carefully is the filter for their day-to-day financial decisions.

But the financial world for their grandchildren is more complex and dangerous then it was for them. The number of debt and accumulation options has increased significantly, so it can be difficult for grandparents to be current with the changing world of personal finance.

Grandparents also need to be mindful of their children. Before setting off to instill financial habits in the grandchildren, the elders should have permission from parents and make sure their values support and reinforce those of the parents.

A good tactic for opening the door to a financial guidance relationship is to establish an account in which grandparents and their grandchildren can collaborate to form good financial habits that will last a lifetime. Here are two accounts that can be considered for this purpose.

• Roth IRA: Regardless of age, anyone can open and contribute to a Roth IRA as long as they have wage income. Money in a Roth IRA can be invested in stocks or mutual funds, and distributions after retirement are tax-free. These also allow for tax-free withdrawals of contributions and penalty-free withdrawals of earnings when taking money out for the first-time purchase of a home. Annual contributions of up to $5,500 to a Roth IRA are allowed.

• Grantor trust: Grandparents who want to give their grandchildren larger financial gifts but want to maintain some control over how the money is managed and when the grandchildren receive it should consider what's called a grantor trust. Under these trusts, the grandparent designates a trustee and spells out in the trust document how the money contributed is used for the child's education, care, etc. The person setting up the trust can make tax-free contributions of up to $14,000 into a trust for each child named as the beneficiary. This most common use for this type of trust is for estate tax planning purposes.

Consider using no-load mutual funds in these accounts because these are professionally managed, diversified and can allow low initial investments and small additional contributions. This is ideal for setting up regular contributions through automatic transfers from a bank account, which teaches the importance of continuous saving and investing. Use the process of selecting a fund as another teaching and guidance opportunity.

Saving for education

The research from TIAA-CREF also points to the importance of putting money away for education. According to the study, 23 percent of grandparents help pay for the college costs of their grandchildren, but two-thirds don't know how a 529 education savings plan works.

529 plans are state-sponsored savings and investment programs ideal to use for saving for future education costs. The grandparent can be the account owner, and the grandchild the beneficiary. The 529 plan provides a menu of investment fund options that can be premixed based on the beneficiary's age.

Additional benefits include:

• The account owner doesn't pay income taxes on the account's earnings.
• The owner has control of the account.
• If the beneficiary/child doesn't go to college, the account can be transferred to another family member and used tax-free for their qualifying education costs.
• Anyone can contribute to the account.
• There are no income limitations that might make someone ineligible for an account.
• Most states have no age limit for when the money has to be used.

Also, if the 529 beneficiary gets a scholarship, an amount equal to the scholarship award can be withdrawn without paying the 10 percent penalty. The account owner will have to include the earnings withdrawn from the account as taxable earnings.

Finally, grandparents who are financially well to do should resist regular splurges on their grandchildren. Instead, take the time to teach them how to save, invest and manage money, and to understand the responsibility that comes with it.