IRA Gifting: How to Help Your Family Now
(Without the Tax Sting) Transcript

Erika Hubbard: The next question is from Lorraine, and she's asking for clarification about some of the lifetime gifting strategies that we've been talking about in this session. She asks, “If you give your child a monetary gift from your IRA, wouldn't it be taxable to them?” For example, if you were to give them $1,000,000, so imagine that you gave it to them during your lifetime.

James Lange: Well, if you take $1,000,000 out of your IRA, then you have to pay tax on that.

Erika Hubbard: Right, but she's asking about what happens with a child, and so this is more about the annual exclusion and the lifetime exemption (I think).

James Lange: Is the money coming from the IRA or from after-tax dollars?

Erika Hubbard: I think she would be taking the money out of the IRA, paying taxes on it, and then gifting it to the child.

James Lange: So, let's say that she wants to make a big gift, right? She has $5 million in her IRA. She wants her kids to benefit from the money now, right? She takes $1,000,000 out of the IRA and she pays the taxes on that $1,000,000 from outside her IRA. Okay? Now she has $1,000,000 and she gifts that to her kids. She uses up $1,000,000 of her exclusion, but who cares because she has $14 million of exclusion, and if she is married, she has $28 million of exclusion, and so, I don't care about that.

Now her kids have $1,000,000. Let's assume that they don't spend it (or they don't spend all of it), and they invest. Is there a tax on that $1,000,000 to the kid? The answer is no.

Then let's say that the kid invests that money. Let's keep it real simple. One kid invests $1,000,000, it earns a taxable 5%. So now that kid has an extra $50,000 in income, and income taxes depending on the tax bracket (let's just say 20%), then the kid is going to have to come up with another $10,000 in taxes. This would be fine, but when I brought that up, I said, “Well, instead of investing in a taxable account (and I wasn't expecting a really big gift), but instead of a taxable account, what if we put it in a 529 plan (education for the grandkids)? What if we put it in a 401(k), or better yet, a Roth 401(k)? What if we put it in life insurance -- all things that grow tax-free? That would be the most strategic use. Or maybe she just wants to help the kids out now for a down payment or even buying them a house (or whatever the use of the money is). I hope that answered the question.

Erika Hubbard: So, the short answer there was not necessarily, and in fact, there are many ways that you could make a gift such as that where your child would not be immediately responsible for paying income tax because of the lifetime exemption and the annual exclusion.

James Lange: Yeah, there would be no gift or transfer tax. And by the way, if the kid doesn't do anything with the money, let's say you give them highly appreciated stock. Well, I don't like to gift highly appreciated stock. I'd rather you wait, die, and get the step-up in basis. But let's say that you give them stock that isn't appreciated. They could sell it for cash. And if they spend it, then there's no tax. If they invest it, then there's just going to be tax on the income that this investment generates. So, there isn't likely going to be a big tax event for the kids receiving a big gift.