Funding Kids's Roth IRA's

[FlaGator]

I match my kids' wage earnings 1:1 (gross income) with a Roth contribution.

The now-college frosh will ring the bell in 2019, hitting the statutory max, and the HS freshman will get ~$1,500. In the past, I funded this from taxable accounts, and could do the same for this year. I attained the all-important age of 59.5 last month, opening up additional options.

My Roth balance is a relatively small portion of total assets at ~ 10%. While I have several years to do conversions, it doesn't look like I could get the Roth balance above 25% of the total accounts without blowing through reasonable marginal tax thresholds. It's also likely the Roth will be the last account I draw from in my twilight years, so this account appears to be destined for my heirs.

Sooooo, I'm thinking the contributions for the kids's accounts could be a withdrawal from my Roth instead of pulling from my "taxable" or regular IRA. Gets the money where I intended, and they don't have to deal with any RMD issues from inheriting my account down the road.

Will be reviewing this approach with my tax accountant in a few weeks. While this makes sense to me, I have to be missing something - what am I missing/ignoring? What should I be asking the accountant about?

I appreciate all comments and perspectives, please share

 

[SevenUp]

Why take from Roth to put into Roth when you could take from taxable and put into Roth?

 

[RunningBum]

Why take from Roth to put into Roth when you could take from taxable and put into Roth?

+1. A Roth is the ideal place for me to hold my assets. Nothing in it will ever be taxed. I want more in my Roth, not less. MRDs from a Roth are not an issue. The recently proposed changes just mean that the advantages of an inherited Roth are lessened, but there are still advantages.

The only reason might be that you can give them taxable assets at a stepped up basis upon your death. However, if they are still low income earners, you can gift them appreciated stock, and they sell it at the 0% LTCG rate, and deposit into their Roth. This has the same effect as the step up basis on death, but you get to keep more in your Roth rather than taxable so anything you withdraw later gets the best tax treatment for yourself.

 

[FlaGator]

Why take from Roth to put into Roth when you could take from taxable and put into Roth?

+1. A Roth is the ideal place for me to hold my assets. Nothing in it will ever be taxed. I want more in my Roth, not less. MRDs from a Roth are not an issue. The recently proposed changes just mean that the advantages of an inherited Roth are lessened, but there are still advantages.

The only reason might be that you can give them taxable assets at a stepped up basis upon your death. However, if they are still low income earners, you can gift them appreciated stock, and they sell it at the 0% LTCG rate, and deposit into their Roth. This has the same effect as the step up basis on death, but you get to keep more in your Roth rather than taxable so anything you withdraw later gets the best tax treatment for yourself.

A good question, and RB's bolded comment applies.

I have worked through all the assets with no tax exposure the last few years, and most of what's left has LTCG of 50%+. Also trying to stay within ACA limits.

I like the gift idea a lot, and will review that with the accountant.

Thanks!

 

[RunningBum]

FWIW, this is exactly what I'm doing for my own son. I did not run it by an accountant though. If they have any warnings about this strategy, I'd appreciate you passing them on. I am not exceeding the annual gift tax amount. It does require the recipient to have a taxable account as well as a Roth.

However, if they are still low income earners, you can gift them appreciated stock, and they sell it at the 0% LTCG rate, and deposit into their Roth.

 

[RE2Boys]

FWIW, this is exactly what I'm doing for my own son. I did not run it by an accountant though. If they have any warnings about this strategy, I'd appreciate you passing them on. I am not exceeding the annual gift tax amount. It does require the recipient to have a taxable account as well as a Roth.

Be careful here and definitely run it by your tax person. If the sale of the gifted assets is done by your dependent child, and he/she has unearned income over $2200, they would be subject to the kiddie tax and estate/trust tax rates apply per the TCJA. The top of the 0% cap gain for estate and trusts is $2650!

Of course, max contribution to a Roth is lesser of $6K or their earned income.

That said, I've been gifting cash to my son's to deposit into their Roths for the past five years. I match their contributions to the Roth (not match their earnings). Incentive to save and not blow all their dough, and also leads to discussions regarding investment choices. One son has mild interest and his Roth is all mutual funds, other son has mixture of broad ETFs and some individual stocks so his Roth is a brokerage account.

 

[RunningBum]

Be careful here and definitely run it by your tax person. If the sale of the gifted assets is done by your dependent child, and he/she has unearned income over $2200, they would be subject to the kiddie tax and estate/trust tax rates apply per the TCJA. The top of the 0% cap gain for estate and trusts is $2650!

Of course, max contribution to a Roth is lesser of $6K or their earned income.

Thank you. My son is not a minor, so this does not apply, but it may to others who read this. I did hit the kiddie tax years ago on CG distributions on a UGMA/UTMA account and it was a hassle. 529s either didn't exist or were too uncertain when I set this up.

 

[upupandaway]

My kids are young at 8 and 9 years old but I'm matching their investments in custodial brokerage accounts with Schwab. Granted we are talking extremely low $$ amounts from gifts and manual labor around the house at this age. My daughter details the inside of a car like a master.

Could you guys tell me more about how you approached the subject of matching the older kids income or their contribution of their income to their ROTH IRA's? I think this idea is amazing and I'm curious about the logistics of the discussion with them. How did you go about offering the incentive? Were the contributions tied to some kind of personal or educational performance?

Kudos to you for educating the kiddos about finance and setting them on the right path!

 

[just walk away]

My kids are young at 8 and 9 years old but I'm matching their investments in custodial brokerage accounts with Schwab. Granted we are talking extremely low $$ amounts from gifts and manual labor around the house at this age. My daughter details the inside of a car like a master.

Could you guys tell me more about how you approached the subject of matching the older kids income or their contribution of their income to their ROTH IRA's? I think this idea is amazing and I'm curious about the logistics of the discussion with them. How did you go about offering the incentive? Were the contributions tied to some kind of personal or educational performance?

Kudos to you for educating the kiddos about finance and setting them on the right path!

Both of my kids got their first W-2 paying summer jobs this year. They both completed freshman year at college. I agreed to 100% fund the first $2000 in their Roths just because they were working for the summer. I then matched their contributions dollar for dollar until the max of their earnings or $6000. It is a great opportunity to teach them about investing. I kept it simple with index and target retirement funds.

 

[upupandaway]

I agreed to 100% fund the first $2000 in their Roths just because they were working for the summer. I then matched their contributions dollar for dollar until the max of their earnings or $6000.

Did you set any stipulations about when or for what they could withdraw your contributions or are you trusting their judgment and the financial education you have provided them?

 

[RunningBum]

It would seem to be a case by case basis whether you demand some performance or have rules. I never tied contributions/gifts to performance--just didn't seem to be right to me. I expressed my wishes what the money was for, but didn't set rules. They aren't enforceable for one thing, and for another this would be a good "practice run". If they are going to withdraw from a Roth for poor reasons, you might decide they need a trust for your estate, or maybe less than you might have otherwise given.

 

[just walk away]

I did stipulate that they were not to take the money out unless they discussed it with us first and that it had to be for a worthwhile goal. I also told them that our future contributions were contingent on them following this rule. I don't anticipate any issues, but they are young and the money is legally theirs. However, they have their summer earnings to blow first if they are so inclined. They will also most likely get these funds eventually though an inheritance (hopefully far in the future) so I think the risk is worth it to teach them more about saving and investing. I set it up so that I have authorized agent access through Vanguard and can monitor and conduct transactions on their behalf. So far they seem very responsible and are saving their summer earnings for graduate school.

 

[just walk away]

I think that once they are out of college, we will probably end the request to talk with us first before withdrawing the money and have no further stipulations. Hopefully, by then they will actually seek out our investment advice, if we are lucky.

 

[kgtest]

I match my kids' wage earnings 1:1 (gross income) with a Roth contribution.

The now-college frosh will ring the bell in 2019, hitting the statutory max, and the HS freshman will get ~$1,500. In the past, I funded this from taxable accounts, and could do the same for this year. I attained the all-important age of 59.5 last month, opening up additional options.

My Roth balance is a relatively small portion of total assets at ~ 10%. While I have several years to do conversions, it doesn't look like I could get the Roth balance above 25% of the total accounts without blowing through reasonable marginal tax thresholds. It's also likely the Roth will be the last account I draw from in my twilight years, so this account appears to be destined for my heirs.

Sooooo, I'm thinking the contributions for the kids's accounts could be a withdrawal from my Roth instead of pulling from my "taxable" or regular IRA. Gets the money where I intended, and they don't have to deal with any RMD issues from inheriting my account down the road.

Will be reviewing this approach with my tax accountant in a few weeks. While this makes sense to me, I have to be missing something - what am I missing/ignoring? What should I be asking the accountant about?

I appreciate all comments and perspectives, please share

My only comment, can you adopt me? Lol, so really what you are accomplishing is reducing your heirs tax burden. Which IMHO is the exact purpose of a Roth for those that have "enough".

I think you are doing the smartest thing given the choices. He will not be able to touch that Roth IRA without penalty until 59.5 .

I never understood why I-ORP calculator tells my ole man to Withdraw/SPEND his Roth $$ right away over the course of a few years...well its because he will be in a higher bracket later so technically it is good for HIS current tax bracket but if you consider the real point of Roth, it's to contribute in the lowest tax years of your working/accumulation days and then withdraw from it in years your taxes will be higher.

I like the idea with larger future inheritances to give some now in Gift via Roth contributions, 529 for the grandkids, and some later in cash. Give early gifts that can accumulate and later give gifts of cash (wedding present, new car, inherited IRA etc).

What good is 1MM to me at 60 when Pops croaks when I could have 500k at 60, and 200k throughout my 50s to help pay for grandkids college expenses, weddings for the grandkids, maybe down payment assistance for a home.

Multi generational planning. By the time my kids are ready to pay for their own kids' college, they 1. Won;t have a mortgage 2. Likely will have enough accumulated family wealth they can ER 3. Have "enough" where likely the Trust will kick out for there own kids home down payments, college, that one way ticket to the new planet, whatever.

Are they trust fund babies, certainly, but that's why we had kids to live alongside them and grow with them. This includes growing the trust.

 

[just walk away]

A good question, and RB's bolded comment applies.

I have worked through all the assets with no tax exposure the last few years, and most of what's left has LTCG of 50%+. Also trying to stay within ACA limits.

I like the gift idea a lot, and will review that with the accountant.

Thanks!

I gifted them shares of Vanguard Total Stock Index from my taxable account being careful to stay within the 0% Capital gains taxes for estates and trusts since we still provide over 1/2 of their support as students. It seems to have worked well and hopefully there is not something that I forgot to consider. I will know for sure at tax time next year.

 

[kgtest]

I gifted them shares of Vanguard Total Stock Index from my taxable account being careful to stay within the 0% Capital gains taxes for estates and trusts since we still provide over 1/2 of their support as students. It seems to have worked well and hopefully there is not something that I forgot to consider. I will know for sure at tax time next year.

Why wait until tax time? I already ran my taxes through last year's TurboTax to project (as close as humanly possible) my tax situation. Even did a few what-ifs in turbo tax to include Roth IRA conversions and some time off for my pregnant wife.

I don't like surprises. I do my 2020 taxes in Q4 2019 as a guesstimate...after all not much changing in terms of tax laws this next year.

 

[just walk away]

Why wait until tax time? I already ran my taxes through last year's TurboTax to project (as close as humanly possible) my tax situation. Even did a few what-ifs in turbo tax to include Roth IRA conversions and some time off for my pregnant wife.

I don't like surprises. I do my 2020 taxes in Q4 2019 as a guesstimate...after all not much changing in terms of tax laws this next year.

Yes I did that and hopefully there are no unintended consequences. I came up with about $4700 (1050+1050+2600 2018 numbers) of LTCG that I could gift to each of them at the 0% rate. Turbo tax did confirm this. I do not use an accountant and this is a new area for me so I am cautious.

 

[RE2Boys]

My kids are young at 8 and 9 years old but I'm matching their investments in custodial brokerage accounts with Schwab. Granted we are talking extremely low $$ amounts from gifts and manual labor around the house at this age. My daughter details the inside of a car like a master.

Could you guys tell me more about how you approached the subject of matching the older kids income or their contribution of their income to their ROTH IRA's? I think this idea is amazing and I'm curious about the logistics of the discussion with them. How did you go about offering the incentive? Were the contributions tied to some kind of personal or educational performance?

Kudos to you for educating the kiddos about finance and setting them on the right path!

Started my boys financial education by first living an LBYM lifestyle which meant being very aware of where our money went. Some time around 9 years old started giving each boy a weekly allowance (started at $5) emphasizing that as a family we share the household chores and the household extras. Only requirement was we expected their full cooperation in helping out around the house (including their room) when asked by Mom or Dad. Only had to withhold an allowance once. Whenever they asked for something, I'd point out that it was up to them to use their allowance money or not. Their were certain classes of activities that we always covered the expenses, such as Scouts and soccer, music lessons. Never general spending money.
Overall rule to this day: unless it is a family activity, any recreational/entertainment activities are their responsibility to pay for.

At 13 they became independent contractors, mostly referees for youth soccer games. Started filing income tax returns.

At 15 they got their first W2 summer jobs and made a few thousand. Opened checking accounts with them. Since I didn't want them to have a lot of pocket money, explained more about saving for the future, offered to match dollar for dollar contributions into a Roth IRA, and that the principle can be withdrawn at any time for an emergency. Left it up to them how much to contribute, as it was their money.
Cell phones: Wanted to be able to contact them ( and vice versa) so covered the cost of a family cell phone plan (currently 4 unlimited plans for $100/month). They started with flip phones and left it up to them to spend their own money for all future phones. (But one Christmas we did offer to pay up to $300 toward newer cell phones).
By senior year in HS, time for credit cards, how they work, that they are responsible for making sure payments are timely (they have never missed). Never spend money you don't have. Once 18, helped them open online savings accounts, move money from local credit union accounts where I have been putting their gift money the past 18 years.

Now almost 23 and 21 (21 months apart in age, one year for school). They have been extremely responsible managing their financial lives so far. They have never asked me for spending money all through HS and now college.

For college, I have supplied each with a vehicle (under $12K), cover insurance and maintenance. Pay for college tuition (state schools), books, R&B, clothing. Again all other expenses are theirs. We cover gas to the extent needed to get to school and back, (and in summer, to work and back) any more is again out of their pocket.

Next challenge, as older son graduates next June, I'll need to ponder what support we would continue to provide if he doesn't find an immediate career type job. Leaning to giving him six months transition period before he needs to start paying R&B, and covering his own car expenses. Also plan on giving cash as a graduation/launch gift but haven't decided on timing---at graduation ? at launch? or wait for Christmas? It'll set a precedent in how works with younger brother a year later.

 

[FlaGator]

I appreciate all the ideas, and potential ptifalls withe the gifting approach.

Will report the accountant's opinion and recommendations after we meet in early November.

As for conditions/restrictions, I didn't put any on them. I can stop the matching if they start pulling out money just to spend. I also continually make clear to them that I was able to leave my job and be a full time parent because their mother and I starting saving in our 20's, LYBM, saved and invested as much as we could, and didn't raid the kitty along the way. Also reinforce the Rule of 72, it's a short and useful conversation in the car

 

[The Cosmic Avenger]

Could you guys tell me more about how you approached the subject of matching the older kids income or their contribution of their income to their ROTH IRA's? I think this idea is amazing and I'm curious about the logistics of the discussion with them. How did you go about offering the incentive? Were the contributions tied to some kind of personal or educational performance?

Kudos to you for educating the kiddos about finance and setting them on the right path!

I've been schooling the kid on saving, compound interest, and the huge advantage in starting early (the "save from 20-30 vs. save from 30 to retirement" scenario) since they were old enough to do arithmetic, and they seem to have a pretty good head on their shoulders regarding spending, frugality, and LBYM. We've told them for a year or two that if they got a job we'd match whatever they made to put in a Roth IRA, but this past summer (the summer before their senior year in HS) was the first time they got a job. It will be a little tight, but we figured that if necessary we could cover up to the maximum, but more likely they'd make less than half that anyway.


This may not last too long, as we're committed to ensuring that they graduate without student debt wherever they go, and we're willing to spend down our taxable investments a bit if necessary to do so, although more likely we'd have them take out student loans and then pay them ourselves quickly after graduation. To us, that's a much bigger contribution to their fiscal future than the Roth contributions...or maybe about on par with each other. Both can give someone a huge, snowballing advantage over what most people (including me) go through during and after college.

 

[MarieIG]

When my kiddos started working I gave them each money to put in a Roth to get them excited about it. That seemed to work. I'm all for the matching idea.

I would probably take from a tax deferred account due to reduce the tax bomb when RMDs come into place. My own Roth I would leave alone to let grow - but ACA subsidies are not a consideration in my case.

For my baby DGD, I gave DS and DDL a check to invest in a cheap total stock market ETF, in their names with her as a beneficiary.

 

[ncbill]

We were fortunate that the oldest kid had a little over $1,000/month (35% of base O-1 pay) in income during undergrad, so they were able to fully fund a Roth those years.

Now they dedicate 20% of salary to Roth TSP (5% match to traditional after 2 years)

 

[SecondCor521]

Next challenge, as older son graduates next June, I'll need to ponder what support we would continue to provide if he doesn't find an immediate career type job. Leaning to giving him six months transition period before he needs to start paying R&B, and covering his own car expenses. Also plan on giving cash as a graduation/launch gift but haven't decided on timing---at graduation ? at launch? or wait for Christmas? It'll set a precedent in how works with younger brother a year later.

I'm planning on gifting to my three kids in the November of the year before they start a full time job. Since the money I'm gifting is their leftover college funds, there will be some modest tax consequences if they choose to take it out and use for non-education purposes. If they do that in November or December while they're still in school, their income that year should be low, and thus the taxes paid on the college money should be minimal.

If I did it the year they start work, the college money would be added to their salary and could be taxed at a higher marginal rate.

 

[FlaGator]

I match my kids' wage earnings 1:1 (gross income) with a Roth contribution.

The now-college frosh will ring the bell in 2019, hitting the statutory max, and the HS freshman will get ~$1,500. In the past, I funded this from taxable accounts, and could do the same for this year. I attained the all-important age of 59.5 last month, opening up additional options.

My Roth balance is a relatively small portion of total assets at ~ 10%. While I have several years to do conversions, it doesn't look like I could get the Roth balance above 25% of the total accounts without blowing through reasonable marginal tax thresholds. It's also likely the Roth will be the last account I draw from in my twilight years, so this account appears to be destined for my heirs.

Sooooo, I'm thinking the contributions for the kids's accounts could be a withdrawal from my Roth instead of pulling from my "taxable" or regular IRA. Gets the money where I intended, and they don't have to deal with any RMD issues from inheriting my account down the road.

Will be reviewing this approach with my tax accountant in a few weeks. While this makes sense to me, I have to be missing something - what am I missing/ignoring? What should I be asking the accountant about?

I appreciate all comments and perspectives, please share

Reporting back after meeting with my accountant.....

Received some good ideas, questions and recommendations, thank you all!

Asked the accountant about 4 potential sources for these contributions:
1. Withdrawal from my Roth
2. Withdrawal from my taxable account
3. Gifting shares from my taxable account
4. Withdrawal from tIRA

Need to note I'm managing income to ACA subsidy levels, so there is that constraint.

His comments on each approach:
1. Why take from the Roth if you want to have more in there? Heard that here
2. Raising money from the taxable account will incur CG on an account that will likely survive my life mostly intact and get a step up in basis. No reason to pay the taxes now.
3. Gifting shares would not incur the "kiddie tax" in my situation, but would reduce the amount for step-up later. Was told to pass on this idea on the basis of "family unit tax"
4. Accountant expects I'll have some room for additional CG/Roth conversion/tIRA withdrawal and remain within ACA limits, and while staying at a low marginal rate. His recommendation was to pull money from the tIRA for the kids' Roth contributions. Also helps (modestly) reduce that account and the future RMD impact.

So, I'm planning to maximize Roth conversion for 2019, and do the withdrawal from the tIRA for the kids in early 2020. Figure that's a different year and I know there will be different factors at play (marriage for one, and the lower marginal tax rate with that).

 

[RunningBum]

Reporting back after meeting with my accountant.....

Received some good ideas, questions and recommendations, thank you all!

Asked the accountant about 4 potential sources for these contributions:
3. Gifting shares from my taxable account
4. Withdrawal from tIRA

Need to note I'm managing income to ACA subsidy levels, so there is that constraint.

His comments on each approach:
3. Gifting shares would not incur the "kiddie tax" in my situation, but would reduce the amount for step-up later. Was told to pass on this idea on the basis of "family unit tax"
4. Accountant expects I'll have some room for additional CG/Roth conversion/tIRA withdrawal and remain within ACA limits, and while staying at a low marginal rate. His recommendation was to pull money from the tIRA for the kids' Roth contributions. Also helps (modestly) reduce that account and the future RMD impact.

So, I'm planning to maximize Roth conversion for 2019, and do the withdrawal from the tIRA for the kids in early 2020. Figure that's a different year and I know there will be different factors at play (marriage for one, and the lower marginal tax rate with that).

I agree that 1 & 2 aren't good choices, so I've removed them. I still think #3 is best. I want to understand why the accountant recommended #4 instead, since I'm in a very similar situation.

It seems to me that with #4, you are no longer maximizing your Roth conversion for 2020 because you are taking some of that tax space for the tIRA withdrawal for the kids.

Let's say you're looking to gift $10K.

With #3, you gift shares that have a large gain. No taxes are paid since (I'm assuming) your son can liquidate them with a stepped up basis. You convert an extra $10K that you wouldn't be able to with #4, so you pay the same tax on conversion or withdrawal, but now your $10K is in a Roth.

With #4, you withdraw the $10K from the tIRA, and that's $10K less you can convert because of the ACA subsidy income level constraint, but you have $10K more left in taxable. You pay the same tax on the withdrawal as you could the conversion. You son is in the same situation with the $10K and a new basis as he had by liquidating gifted shares with a stepped up basis.

So your son is in the same place, and you have paid the same current taxes. But with #3, you have $10K in your Roth rather than appreciated shares in taxable, so if you do need the money, you can access it tax free, so you're better off. And your son inherits $10K more in a Roth and $10K less in stepped up taxable. Even if the new inherited IRA rules take effect, he'll still have some time to let that $10K grow tax free in the Roth for a few years so he's better off.

With #4, if it turns out you'll need that 10K, you're going to have to sell appreciated shares from taxable, so you'll incur LTCG taxes on the sale. Also, any dividends that $10K throws in taxable is subject to tax, and eats into the amount you can convert under the subsidy cap. If you don't have to sell it, your son inherits money in a taxable account rather than a Roth, which is less preferable.

As I say, I ask because I face this same situation and want to see if there's an error in my analysis. Also, I hear people often say it's worth hiring a tax pro for questions like this, but it looks to me your tax pro has given you less than optimal advice, for a fee. I think there's no substitute for understanding and analyzing your situation yourself, and only consider hiring a tax pro if you aren't sure of tax laws. There is nobody more motivated to make the right direction than you.

That said, you were considering option 1, which is worse than 3 or 4, so maybe it was worth your while. I just think you paid to get a better option, but for free here you could get the best option. Understandably you may trust your accountant more than me (SGOTI--some guy on the internet), but I say don't blindly trust anyone.

ETA: I made the following assumptions:
1) your sons in high school and college can liquidate gifted shares at 0% LTCG rate;
2) you are managing your income for subsidies (which you said) so you will take the same amount of your tIRA either way, it's just a question whether it's all a conversion, or some a withdrawal to gift;
3) and you may have trouble fully converting your tIRA before MRDs, which you hinted at.

I'm not sure what impact your marriage next year has on this, other than more room to convert tIRAs and still get the ACA subsidy. Perhaps with this space you can fully convert your tIRA either way.