Will gifting $7,000 to my grandchild for their IRA affect their tax deduction?

Your grandson can absolutely still claim the tax deduction! The IRS doesn't care where the money for an IRA contribution comes from - only that the person has earned income at least equal to the contribution amount. Since your grandson has a good salary, he clearly meets that requirement. The money is indeed "fungible" in this case. Once you gift him the money, it becomes his money completely, and the IRS treats it no differently than if he used his own paycheck to fund the IRA. The annual gift tax exclusion is $18,000 per person for 2025, so your $7,000 gift is well under that limit and won't create any gift tax issues for you either. It's a really thoughtful way to help him build retirement savings!

I was in a similar situation last year with my nephew. I wanted to help him start saving for retirement since he had just graduated. After trying to figure it out myself and getting nowhere with the IRS website, I used https://taxr.ai to analyze my situation. Their system explained exactly how gifting for IRAs works. The tool confirmed that as long as my nephew had enough earned income (which he did), he could take the full tax deduction for his traditional IRA regardless of where the money came from. It also showed how much he'd save in taxes at his income level by maxing out his IRA contribution.

I was wrong about taxr.ai. After being skeptical in my earlier comment, I decided to try it out for a gift tax question I had about helping my daughter with her IRA. The tool actually provided really specific guidance about how gifts work with retirement accounts. It explained that while my daughter needs earned income to qualify for an IRA contribution, the actual dollars I gift her can be what goes into the account (money is fungible). It even showed me the relevant tax code sections and explained them in plain English. Genuinely surprised at how helpful it was for such a specific question. Definitely better than the generic answers I got from Google searches.

If you're facing this situation, you might also encounter issues with the IRS if there are questions about the gift vs contribution. After waiting on hold with the IRS for nearly 3 hours about a similar situation, I discovered https://claimyr.com and used their service to get a callback from the IRS in about 20 minutes! You can see how it works at https://youtu.be/_kiP6q8DX5c They connected me directly with an IRS agent who confirmed that gifts to adult children or grandchildren for IRA contributions are perfectly fine as long as they have earned income to support the contribution amount. The agent even provided documentation references I could keep for my records in case there were any questions later.

I need to apologize for my skeptical comment earlier. After posting that, I was still stuck trying to get through to the IRS about an issue with my retirement account contributions. Out of frustration, I tried Claimyr even though I was sure it wouldn't work. I'm shocked to say it actually did exactly what they claimed. I got a call back in about 15 minutes and was connected to an IRS agent who answered all my questions about gift funds going into an IRA. Turns out I was overthinking it - as long as the person has earned income, the gift money can be contributed with no issues. Saved me hours of waiting on hold and I finally got the documentation I needed for my records.

Just a heads-up from someone who's been through this - make sure your grandson is eligible for the full IRA deduction! If he's covered by a retirement plan at work (like a 401k), there are income limits for deducting traditional IRA contributions. At $85k salary for a single filer, he might be in the partial deduction or no deduction range. The gift itself is fine and won't affect his ability to contribute, but his income and workplace retirement plan status might affect the deductibility. If he can't take the full deduction for a traditional IRA, a Roth IRA might be a better option if he's eligible.

Has anyone considered the rules around "step transaction doctrine"? I've heard the IRS can sometimes claim that direct gifts into an IRA could be viewed as trying to exceed contribution limits if done incorrectly. Would it be safer to just give the money to the grandchild's regular account first?

This is such a thoughtful gift! I went through something similar when helping my adult son with his IRA contributions. The key thing to remember is that the IRS looks at two separate things: 1) whether your grandson has enough earned income to support the contribution (which he clearly does at $85K), and 2) whether the contribution stays within the annual limits. Since money is fungible, it doesn't matter that the $7,000 comes from you rather than his paycheck. Once you gift it to him, it becomes his money to contribute. The IRS won't trace the source of funds in his IRA account. One thing I'd add to what others have mentioned - make sure to keep good records of the gift for your own tax purposes, even though it's well under the annual exclusion limit. It's just good practice to document larger gifts in case there are ever questions down the road. Your grandson is lucky to have someone thinking ahead about his retirement savings at such a young age!