Funding Kids's Roth IRA's

[gauss]

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 .

In general, Roth IRA contributions can be withdrawn at ANY age with out taxes or penalty.

gauss

 

[SevenUp]

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.

Unless you are invested in something that produces no annual earnings, you could use dividends and interest from the taxable account (and/or cash, depending on the size of your cash balance).

 

[kgtest]

You are correct. Dang. Not sure why I typed 59.5. Thsts thr typical restrictions for IRA. Not Roth. Apologies for miscue.

 

[The Cosmic Avenger]

In general, Roth IRA contributions can be withdrawn at ANY age with out taxes or penalty.

gauss

Except for the 5-year rule...although I believe withdrawals are considered to come from the "oldest" contributions and their proceeds, so it's usually not an issue unless you're closing it out within 5 years of your last contribution.

 

[SecondCor521]

Except for the 5-year rule...although I believe withdrawals are considered to come from the "oldest" contributions and their proceeds, so it's usually not an issue unless you're closing it out within 5 years of your last contribution.

gauss' comment was about withdrawing Roth contributions. The link you provided talks about three different 5 year rules, none of which apply to withdrawing Roth contributions, so I don't understand your comment.

 

[The Cosmic Avenger]

gauss' comment was about withdrawing Roth contributions. The link you provided talks about three different 5 year rules, none of which apply to withdrawing Roth contributions, so I don't understand your comment.

The 5-year rule applies in three situations:

• You withdraw earnings from your Roth IRA. [OR]
• You convert a traditional IRA to a Roth IRA. [OR]
• You inherit a Roth IRA.

If you only started a Roth IRA this year, 2019, and put in $1K per year (let's ignore the proceeds on those contributions because that just complicates the calculations), you couldn't withdraw any money without taxes or penalties for 5 years, 2024. In 2024, you could withdraw the first year's $1K (and its proceeds, which we're ignoring for now) without penalty.

 

[SecondCor521]

If you only started a Roth IRA this year, 2019, and put in $1K per year (let's ignore the proceeds on those contributions because that just complicates the calculations), you couldn't withdraw any money without taxes or penalties for 5 years, 2024. In 2024, you could withdraw the first year's $1K (and its proceeds, which we're ignoring for now) without penalty.

I disagree with your assessment. The portion of the article you quoted is accurate, but I think you're misunderstanding or misapplying it. The key word to understand is "earnings" and the IRS withdrawal ordering rules.

If I start a Roth in 2019 and put in $1K this year, I believe I could withdraw $1K tomorrow without taxes or penalties. (This is how some people decide to use their Roth as an emergency fund. Not something I would do necessarily, but it's where the idea comes from.)

Any proceeds on that $1K would have to remain in the Roth IRA until age 59.5 to be withdrawn penalty free. So if I stuck it in a money market for a month and it earned $2 in interest, then that $2 would have to stay in the Roth. That's what the bolded part of the article you quoted says.

Regardless of what happens inside the Roth IRA (buy/sell/dividend/cap gain/cap loss/interest), the IRS deems you to withdraw contributions first, then conversions, then earnings. They look at it in terms of dollar amounts and years only - they don't tie the $1K I put in this year to, say, 105 shares of Nike, or anything like that. So when I withdraw $1K from my $1,002 Roth IRA, it's deemed as coming from my $1K 2019 Roth contribution first because of the IRS ordering rules.

Here's an Investopedia article on ordering rules:

https://www.investopedia.com/terms/o/orderingrules.asp

 

[SevenUp]

If I start a Roth in 2019 and put in $1K this year, I believe I could withdraw $1K tomorrow without taxes or penalties.

That is correct.

 

[FlaGator]

Originally Posted by FlaGator
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.

There is no step on in basis for gifted shares - the recipient inherits your basis. A few references:
https://www.irs.gov/faqs/capital-ga...e-of-home-etc/property-basis-sale-of-home-etc
https://www.kiplinger.com/article/taxes/T055-C001-S003-taxes-on-a-gift-of-stock.html

The offspring may be able to sell at 0% LTCG, but there will be tax consequences for the "family unit".

 

[RunningBum]

There is no step on in basis for gifted shares - the recipient inherits your basis.

Yes, I misspoke. What I meant is that your son can probably sell them at 0% LTCG rate. That's like a stepped up basis, but I was totally incorrect to use that term.

 

[FlaGator]

snipped...

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.

 

[RunningBum]

I'll try again, with my terminology error fixed, and the unnecessary and perhaps inflammatory extra commentary removed.

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. I think #3 is better.

Let's say you're looking to gift $10K to a son, and also plan to maximize Roth conversions as best you can.

With #3, you gift shares that have a large gain. No taxes are paid since (I'm assuming) your son can sell them at the 0% LTCG rate. You can 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 an extra $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 ($10K and $0 tax liability) 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.

 

[FlaGator]

All good

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. I think #3 is better.

Let's say you're looking to gift $10K to a son, and also plan to maximize Roth conversions as best you can.

With #3, you gift shares that have a large gain. No taxes are paid since (I'm assuming) your son can sell them at the 0% LTCG rate. You can 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 an extra $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 ($10K and $0 tax liability) 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.

In most circumstances, your approach would be good. However, the oldest kid killed it working her senior HS year and gifting appreciated shares for a Roth contribution would push her into the "have to file" category. Even though her CG rate would be zero, I would then have to include her total income in my ACA calcs as part of the household - the "family unit" problem. Since her earnings far exceed the statutory limit, it would reduce my conversion amount more than would go to her Roth.

In the case of an independent adult offspring, gifting may not have the same effect, but as she is part of my household for ACA purposes, it doesn't make sense - in this specific situation. If there was a "step up" in basis, it wouldn't be an issue as there would be no reportable gain. Hope I have described this in a way that makes sense.

You are correct that deferring the tIRA withdrawal to 2020 reduces conversion room next year. I'm taking it a year at a time on conversions and evaluating staying in ACA subsidies on an annual basis as well. Lot of things in play-business interests, pending marriage, kids in college, etc. Have tried to do long-term planning on Roth conversions, but have found it impractical. Opportunistic year end review has worked the best.

Back to my original question of a Roth withdrawal to fund the kids' Roths - If I didn't have room to take money from a lower tax/ACA MAGI source (turns out I do), it would be a way to pass that money along at a low tax cost while keeping my nose in the government health care trough

 

[RunningBum]

In most circumstances, your approach would be good. However, the oldest kid killed it working her senior HS year and gifting appreciated shares for a Roth contribution would push her into the "have to file" category. Even though her CG rate would be zero, I would then have to include her total income in my ACA calcs as part of the household - the "family unit" problem. Since her earnings far exceed the statutory limit, it would reduce my conversion amount more than would go to her Roth.

In the case of an independent adult offspring, gifting may not have the same effect, but as she is part of my household for ACA purposes, it doesn't make sense - in this specific situation. If there was a "step up" in basis, it wouldn't be an issue as there would be no reportable gain. Hope I have described this in a way that makes sense.

You are correct that deferring the tIRA withdrawal to 2020 reduces conversion room next year. I'm taking it a year at a time on conversions and evaluating staying in ACA subsidies on an annual basis as well. Lot of things in play-business interests, pending marriage, kids in college, etc. Have tried to do long-term planning on Roth conversions, but have found it impractical. Opportunistic year end review has worked the best.

Back to my original question of a Roth withdrawal to fund the kids' Roths - If I didn't have room to take money from a lower tax/ACA MAGI source (turns out I do), it would be a way to pass that money along at a low tax cost while keeping my nose in the government health care trough

Hmm, that does complicate things, quite a bit. I could see how that would most likely favor #4, as you and your advisors determined.

I will apologize for my previous extra remarks, not just because the advisors were right, but because it wasn't my business. I really was trying to speak generally and not criticize or demean you, but I do see how that could be taken wrong. Thanks for moving on past that.

Roth conversion has a lot of moving parts for most people, and you seem to have more moving parts than most. I can definitely see why you'd take it year by year, and just convert what you can each year.

 

[FlaGator]

The Conclusion

Thought it might be informative to share the decision on source of funds, as well as additional analysis I did.

Quick recap - I was evaluating funding the kids Roth accounts from 3 possible sources:
1. Withdrawal from my regular IRA
2. Withdrawal from my Roth IRA
3. Raise money from my taxable account

There were two other factors at play:
-Staying within ACA limits, so the Roth option gave me the most flexibility on that front.

-I'm getting remarried in 2020 and will have more ACA headroom as well as lower tax rates.

Advice from the accountant was consistent with this board on the Roth, but he recommended a Regular IRA withdrawal. Shrinks the tIRA (one of my goals) and defers/eliminates taxes on the "taxable" account that would get a step up in basis later. He ruled out gifting shares as doing so would put my ACA subsidy at risk.

I decided to postpone action on the kids' accounts until 2020 and take advantage of the ACA room to do another Roth conversion.

While doing planning for 2020, another option emerged - take the money from the substantially-overfunded 529s. These accounts were funded early in their lives and my basis is ~40%. There would be ordinary income tax, as well as a 10% penalty, to pay on the gain.

I did the tax analysis again The option that gives me the most flexibility and lowest taxes was to sell MF with the smallest gain (<20%).

So, I pulled the trigger on that yesterday and will get the accounts funded once their W-2s are in hand.

Yes, I paid for advice, then made a different decision

 

[The Cosmic Avenger]

While doing planning for 2020, another option emerged - take the money from the substantially-overfunded 529s. These accounts were funded early in their lives and my basis is ~40%. There would be ordinary income tax, as well as a 10% penalty, to pay on the gain.

Sounds like a plan! I just looked at the kid's last pay stub, and the total is a hair over $3K that we promised to match.... I think I'll take the RMD from an inherited IRA, but I'll wait and do it closer to filing time.

 

[SecondCor521]

While doing planning for 2020, another option emerged - take the money from the substantially-overfunded 529s. These accounts were funded early in their lives and my basis is ~40%. There would be ordinary income tax, as well as a 10% penalty, to pay on the gain.

To the extent that your kids get/got scholarships, you can avoid the 10% penalty.

 

[pb4uski]

....He ruled out gifting shares as doing so would put my ACA subsidy at risk. ....

I don't get the logic of that... ACA subsidies are based on tax return income and has nothing to do with gifting.

 

[FlaGator]

I don't get the logic of that... ACA subsidies are based on tax return income and has nothing to do with gifting.

The kids would have to sell the gifted shares at my (low) basis and the gain would push them into the "required to file" category and their *total* income would be included in the household total for ACA. Right now, their part time income is below the threshold and excluded from household ACA MAGI, leaving me more room for CG and Roth conversions.

Hope I explained that in a way that makes sense.