Using a Roth for a DIY 529(ish) Plan

[CRLLS]

Following the "gifting with a warm hand" thread. DW and I want to help our grandchildren with their college expenses. Not a large amount, but enough to ease the burden a little. However, we want to provide some choices on their part and to incentivize good choices. My grandchildren are of ages 5 thru 17,

We are thinking of doing a one-time transfer, taking money from my Roth this year and creating several other Roths under my name, one earmarked for each of them and invested in relatively guaranteed investments primarily to prevent loss and possibly keep up with inflation for those younger ones. For the purpose of this discussions, disregard any choices of the investments.

In the event that the grandkids get scholarships and/or do not need that money for tuition directly, AND GRADUATE (a very important condition), any remaining amount would become a lump sum gift to help start out their adult life. It would likely be less than the annual gift limit for reporting gifts or could be split into a couple of years if needed.

With the new Roth's, I would plan to setup each of them with their father's name as beneficiary. In the event that I pass before they are out of college, their father can manage the payouts.

My thinking is that since I have had the Roths for so many years and am well over 59.5 etc, any withdrawals by me would be tax-free. I get to choose the investments. And there would be no fees. The younger ones will benefit from the growth, hopefully in step with inflation making their gift roughly equivalent to the older one's. In the event that one of them unfortunately passes before the age of college, that money would still be ours to choose how to handle it.

I think that this is a better choice for us than a 529 plan as we have control of the carrot and can distribute as we wish. Is there anything that we should be aware of that would prevent this idea from happening? Or anything else that we should consider?

 

[Closet_Gamer]

Two thoughts:

You maintain full control with a 529 plan as well. You are the account owner whereas the grandkids are just beneficiaries. You press "go" on the distribution and can send it straight to the school, yourself or the beneficiary. Downside is that you need to maintain some proof that it was an education qualified distribution. You don't need that with a Roth.

Rather than setting up a bunch of accounts, it may be easier to just manage one account with some spreadsheet on the side to track who gets what. You can then just update your will accordingly to have the money distributed to the parents to run it.

Congrats on supporting the grandkids.

 

[SecondCor521]

Miscellaneous thoughts and comments:

Carrots work well for little kids. My experience, and I'm sure it varies very widely, is that carrots don't work well on college age young adults. I would suggest ruminating on whether you are gifting or bribing or rewarding.

The plan as you've described it will work. I think you realize that the distributions from your Roth would lose their tax free status and would go to the kids' taxable side of their assets first. They could contribute to their Roths, of course, if they qualify.

You could still do the carrot approach with a 529; at least I don't see why not.

The 529 fees are a drawback; that may be offset by any state tax benefit for contributions. It sort of depends on what your (or their) state tax benefits are for 529 contributions and how long the money would remain in the plan.

There is a new 529->Roth rollover rule that might interest you. There are multiple restrictions that apply that may not make it work for you, especially for your older grandkids, unless there are already 529s around for them.

 

[CRLLS]

Closet_Gamer, I really am not up to speed with 529's. Setting up the separate Roths allows me to separate the beneficiaries between the parents without anyone having to find the spreadsheet That makes it a bit easier than keeping a Will up to date annually. At least that's what I think.

SecondCor521, WRT gifting, bribing or rewarding. I guess one could see it that way. And I think my intention may be a bit of a mixture. It could be considered as a gift if it is used for the tuition. Or it could be called a reward if not used for tuition but used after graduation to start their adult life. As for possibly being a bribe, maybe as a carrot to complete their undergraduate studies. In all situations, the choice is theirs. The only way they lose is if they drop out. Since the giving is for a purpose, I don't think that is too much of a condition.

My limited knowledge of a 529 plan is that the limited choices of investments, the fees, justification that the money seems to need some record keeping/possible approval and the possible changes to the plans in the future are all deal breakers for me. That last one, the rules changing in the future, could happen with the Roths too. Being all of the Roths are under my name, I could always re-combine them and just give out the money as I choose. Although that may be a bad thing to do once I set out the plan to all involved.

 

[youbet]

My limited knowledge of a 529 plan is that the limited choices of investments, the fees

You very much do need to up your knowledge of 529b plans in order to make the best decision. I don't know anything about 529b plans in your state, but here in Illinois (yes, corrupt, broke Illinois) our state 529b plan has a great selection of funds built around primarily Vanguard funds and very low fees. I've been very pleased. Your state may vary but becoming familiar with the details in any state is easy-peasy.

I'm 100% funding college and grad school for 3 grand kids. I did start very early in their lives with state tax deductible contributions annually and that has resulted in accounts which are now approximately 25% my contributions and 75% investment gains. The investment gains are withdrawn tax free which is nice. Really quite painless. I hope they appreciate it!

You're doing something different with a plan being funded later in some of the kiddo's lives. So, no doubt, your situation is different. Still, upgrade your knowledge of your state's 529b plan so you can make an informed decision.

https://brightstart.com/

Edit: Just noticed you're also in Illinois. Don't know about your personal tax situation but in Illinois 529b contributions, up to $20k, are deductible for Illinois state income tax. So, if you contribute $20k and take that deduction, you'll save $1k on your Illinois taxes. This applies even if you immediately withdraw the money.

You may want to consider a 529b plan for the youngest grand kids and use your Roth IRA plan for the oldest.

 

[youbet]

Downside is that you need to maintain some proof that it was an education qualified distribution.

We have a senior in college we've been funding via 529b withdrawals and, so far, the record keeping has been a breeze. Amazingly, the IRS doesn't require much. Funding the 529b ($10k/yr since she was an infant) was 99% of the chore. Keeping receipts for tuition, room and board, and any significant other qualified expenses (books, computer, etc.) has been 1% of the chore.

 

[cat4ever]

state tax deduction is the diff

I agree with some of the others here, why pass up the state tax deduction on the principal, which you won't get on the Roth. You should at least be taking that into consideration if you haven't. Sounds like IL (like MO where I'm it) may have good options for investments, and low fees.

 

[CRLLS]

cat4ever, Thanks for your advice, I'll look into the 529. However, I think you are a bit confused. I do plan on taking this funding from my Roth either way. Illinois does not tax any withdrawals from any retirement plan. tIRA, Roth, 401K pensions, are all treated the same, not taxation.

Youbet, I do agree that I don't know much about 529b plans here in Illinois. At the moment, my plan is to make one contribution, I do not want to, nor can afford to fund the entire cost of college for any of them. I do feel that they should provide some part of their education. Both of my children feel the same way about their children being part of the equation. My guaranteed taxable income for Illinois is zero, so there is no saving of taxes. There is some interest and qualified dividend income that is taxed but that is not one that can be counted on from year to year.

All things being equal and given that the money will come from my Roth, which will likely never be used for my expenses, what do you see as the pros and cons of a real 529 plan vs my proposal?

 

[youbet]

My guaranteed taxable income for Illinois is zero, so there is no saving of taxes.

All things being equal and given that the money will come from my Roth, which will likely never be used for my expenses, what do you see as the pros and cons of a real 529 plan vs my proposal?

OK, then I guess the question boils down to whether you move some money from your Roth IRA to 529b accounts for the grand kids or just hold it in the Roth (or the new Roths you mentioned setting up, no real difference) and dole it out to them from there. Illinois state income taxes are not part of the decision making since you pay none.

The only drawback to the Roth plan is that there is actually no guarantee that the money will be used for educational purposes if the expenses come after you pass. The beneficiaries, your kids, inherit the Roths and do with them as they please. Hopefully, per your wishes.

If you do any college funding with non-Roth money, and especially if you begin paying some Illinois taxes, I would recommend using 529b's for that money. But, I wouldn't move your Roth IRA money to a 529b, especially since you aren't paying Illinois state income taxes.

 

[Sunset]

OP - Since you are in IL, why not do it from your IRA (either accounting, or really set up separate IRAs). Since the withdrawals are tax free in IL it will act exactly like a Roth, except to increase your income when payouts happen.

 

[CRLLS]

OP - Since you are in IL, why not do it from your IRA (either accounting, or really set up separate IRAs). Since the withdrawals are tax free in IL it will act exactly like a Roth, except to increase your income when payouts happen.

Interesting idea. Thanks. IRA money would be federally taxed though. I will be hitting RMD time next year. I could use that money to "effectively exchange" the Roth benefit instead of actually depleting the Roths. The taxes would have to be paid anyway. Should I pass, the Roth money would transfer according to the stated beneficiary. I'm good with that. Along the way, I could use the Roth as a managing tool for the 3 separate packages allowing them to safely grow without any actual spreadsheet work. When the time comes. use the RMD money (actually from a taxable account once annual RMD transactions are made) to distribute the money over 4 years. Once all the little ones complete their education, I can reverse the 3 Roths back into my main Roth. I like that idea.

Life usually throws us surprises when we make plans. Flexibility is necessary for any plan. Fortunately, we have many options when our SS and a small annuitized LI policy cover our day-to-day expenses.

 

[CRLLS]

I met with the new Fido advisor and discussed this plan with her. She said it can be done, told me how to open the new Roth accounts online, which I have done. She even suggested that, if I wanted, I could set up each Roth account with a viewing-rights only for the parents to track the account balances.

Now I have a question. I know that I can have many Roth IRAs as I wish. I also know I can only "transfer" from a Roth to a Roth and that has no tax implications. And if it is "transferred" from one institution to another, I am limited to one per calendar year. I cannot find anywhere what the limitations are for moving money from one Roth IRA to a Roth IRA within the same institution. Further, if I move one time from one account to three different accounts at the same time, is that counted as one or three?

I have searched the 'net and not found where the IRA has anything like this in their website. Any help and IRS references would be appreciated.

 

[SecondCor521]

I met with the new Fido advisor and discussed this plan with her. She said it can be done, told me how to open the new Roth accounts online, which I have done. She even suggested that, if I wanted, I could set up each Roth account with a viewing-rights only for the parents to track the account balances.

Now I have a question. I know that I can have many Roth IRAs as I wish. I also know I can only "transfer" from a Roth to a Roth and that has no tax implications. And if it is "transferred" from one institution to another, I am limited to one per calendar year. I cannot find anywhere what the limitations are for moving money from one Roth IRA to a Roth IRA within the same institution. Further, if I move one time from one account to three different accounts at the same time, is that counted as one or three?

I have searched the 'net and not found where the IRA has anything like this in their website. Any help and IRS references would be appreciated.

As long as it is a direct transfer, which is what you're describing if it's at the same institution, you can do as many as you want.

Cite: https://www.irs.gov/retirement-plan...vers-of-retirement-plan-and-ira-distributions at "Direct transfers of IRA money are not limited"

 

[CRLLS]

Thanks for the link SecondCor521. To be honest, I get quite confused about the "transfer" terminology. Everywhere I look, including your link, says that a "transfer" is moving a Roth to a Roth from trustee-to-trustee. And this does not have a limitation on how many you can do. But nothing about moving a ROth to a Roth with the same trustee. Maybe I am overthinking this and should just ask Fidelity?

To add to my confusion, I have found this "Rollover" chart from the IRS that says Roth IRA to a Roth IRA is limited to one in every 12-month period. What would qualify a transaction such as I plan as a "rollover"? The chart seems to be a contradictory to the unlimited number of transactions you mentioned earlier.

 

[Sunset]

..
To add to my confusion, I have found this "Rollover" chart from the IRS that says Roth IRA to a Roth IRA is limited to one in every 12-month period. What would qualify a transaction such as I plan as a "rollover"? The chart seems to be a contradictory to the unlimited number of transactions you mentioned earlier.

My understanding is:

A rollover that is trustee to trustee (where you don't touch/see the $$) is unlimited.

A rollover that is you get the cash and then deposit it is once per 12 months.

 

[cathy63]

Thanks for the link SecondCor521. To be honest, I get quite confused about the "transfer" terminology. Everywhere I look, including your link, says that a "transfer" is moving a Roth to a Roth from trustee-to-trustee. And this does not have a limitation on how many you can do. But nothing about moving a ROth to a Roth with the same trustee. Maybe I am overthinking this and should just ask Fidelity?

To add to my confusion, I have found this "Rollover" chart from the IRS that says Roth IRA to a Roth IRA is limited to one in every 12-month period. What would qualify a transaction such as I plan as a "rollover"? The chart seems to be a contradictory to the unlimited number of transactions you mentioned earlier.

That chart is not very clear regarding the one-year rule. It's designed to show which kind of accounts can be the source and destination for rollovers, but it's not providing all the details for each type of transaction. Here is an official IRS explanation of the one-year rule that hopefully allays your concerns: https://www.irs.gov/retirement-plan...vers-of-retirement-plan-and-ira-distributions

IRA one-rollover-per-year rule

You generally cannot make more than one rollover from the same IRA within a 1-year period. You also cannot make a rollover during this 1-year period from the IRA to which the distribution was rolled over.

Beginning after January 1, 2015, you can make only one rollover from an IRA to another (or the same) IRA in any 12-month period, regardless of the number of IRAs you own (Announcement 2014-15 and Announcement 2014-32). The limit will apply by aggregating all of an individual’s IRAs, including SEP and SIMPLE IRAs as well as traditional and Roth IRAs, effectively treating them as one IRA for purposes of the limit.

The one-per year limit does not apply to:

• rollovers from traditional IRAs to Roth IRAs (conversions)
  [*]trustee-to-trustee transfers to another IRA
• IRA-to-plan rollovers
• plan-to-IRA rollovers
• plan-to-plan rollovers

(The highlighting is mine.) What you are proposing to do is a trustee-to-trustee transfer where both trustees are Fidelity. You can do as many of these transfers as you want in a year. You could also do as many transfers as you want if one trustee is Fidelity and the other is someone else, such as Schwab or Vanguard.

 

[CRLLS]

According to the IRS, a "Rollover" is defined as changing the "type" of retirement account and can either be within a single trustee or from one trustee to another. I am not trying to change trustees. A " transfer" is moving from one trustee to another. Also I am not doing this.

I cannot find the rules for where I am moving money from one Roth to another Roth within a single trustee.

 

[SecondCor521]

I cannot find the rules for where I am moving money from one Roth to another Roth within a single trustee.

As @cathy63 posted immediately above, you're doing a trustee to trustee transfer; it just so happens that both trustees are the same.

If you're still unsure, I'd recommend asking your qualified tax preparer. Or the IRS, but it's hard to get them on the phone.

 

[Sunset]

According to the IRS, a "Rollover" is defined as changing the "type" of retirement account and can either be within a single trustee or from one trustee to another. I am not trying to change trustees. A " transfer" is moving from one trustee to another. Also I am not doing this.

I cannot find the rules for where I am moving money from one Roth to another Roth within a single trustee.

I think you are worried about nothing.

However, you could
transfer from Trustee A to Trustee B (will need to open an account).
Then next week
transfer from Trustee B to new Roth Account at Trustee A.
Repeat as often as you like, can use the same Trustee B account for all the transfers.

 

[CRLLS]

Cathy62, SecondCor521 and Sunset, thanks for the comments. I get that transferring From a Roth to a Roth within the same trustee should be the same as from a trustee to different trustee. However, the tax rules are not always logical nor are they constant. I really don't want to make a mistake.

I plan on calling Fidelity on Tuesday to get their confirmation. I'll post their answer. I have already sold a position to make the transfer in actual $$ and not shares. The investment will be different from what they were in previously.

 

[SecondCor521]

Cathy62, SecondCor521 and Sunset, thanks for the comments. I get that transferring From a Roth to a Roth within the same trustee should be the same as from a trustee to different trustee. However, the tax rules are not always logical nor are they constant. I really don't want to make a mistake.

I plan on calling Fidelity on Tuesday to get their confirmation. I'll post their answer. I have already sold a position to make the transfer in actual $$ and not shares. The investment will be different from what they were in previously.

Fidelity should (and most likely will) tell you to consult your tax advisor. Fidelity is an investment firm, not a tax advisory firm.

 

[CRLLS]

Fidelity should (and most likely will) tell you to consult your tax advisor. Fidelity is an investment firm, not a tax advisory firm.

Come the end of the year, they will be issuing the 1099 indicating one way or the other. I'm sure that their backroom knows.

 

[SecondCor521]

Come the end of the year, they will be issuing the 1099 indicating one way or the other. I'm sure that their backroom knows.

Fair point. I'll be interested to hear the result.

 

[youbet]

In the event that the grandkids get scholarships and/or do not need that money for tuition directly, AND GRADUATE (a very important condition), any remaining amount would become a lump sum gift to help start out their adult life.

Under your plan (which seems fine to me BTW) would GRADUATION be a "condition" or just a "suggestion." Upon your death, the Roth IRA would belong to the child's father to handle as he wishes.

 

[MrsHaloFIRE]

OP you said these kids are young. You are setting up seperate Roths in YOUR name? You cant do a Roth in their name without them having earned income. Unless Im misreading what you are saying