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Can You Give Part of Your IRA to Your Family Tax Free?

Dear Carrie,

Can my wife and I gift part of an IRA to family members without tax to us? Our kids are grown and married. We are age 70. 

—A Reader

Dear Reader,

If you've contributed for years to a tax-advantaged IRA and now don't need it to fund your own retirement, it would seem to make sense to give part of it to a family member. And, of course, you can. However, the taxes you pay depend on the type of IRA you have.

You don't say whether you have a traditional or a Roth IRA, and the tax rules for each are very different. With a Roth, contributions are made with after-tax dollars (the government gets its share upfront) and withdrawals (regardless of what you do with the proceeds, including making a gift) are tax-free. However, because contributions to a traditional IRA are made with pre-tax dollars, in spite of your generous desires, the IRS still wants its share. So if you have a traditional IRA, the short answer is no, you can't avoid paying income taxes on a withdrawal by making it a personal gift.

To put it in a more positive light, traditional IRAs are designed to encourage people to prepare for retirement by giving them a tax incentive to save during their working years, when they might be in a higher tax bracket. For them, withdrawals during retirement years would be taxed at a lower rate.

And that may very well be the case for most folks. However, whether you use the money for yourself or give it to someone else, it's considered ordinary income, and you have to pay taxes at whatever your tax rate is the year you make the withdrawal.

That doesn't mean you can't be generous. It just means that you have to look at any gifts you make within the context of your bigger tax picture.

Review the gift tax rules

Income taxes aren't the only type of taxes you need to think about. You also need to be aware of how much you can give gift-tax free. In 2014, an individual can give up to $14,000 a year to any number of people without paying gift taxes, or even reporting the gifts.

However, as soon as you give more than $14,000 to any one individual, you have to file a gift tax return. That doesn't mean that you'll have to pay taxes on the gift. It just means that the amount above $14,000 will be applied to what's called your lifetime exclusion. This is the total amount you can give away during your lifetime beyond the yearly limit without incurring a gift tax. For 2014, the exclusion is $5.34 million, so gift taxes aren't a concern for most people.

Married couples can give up $28,000 a year to any number of individuals if they agree to what's called "gift splitting." They do have to file a gift tax return, but it won't count against their lifetime exclusions. So, for instance, you and your wife could give $28,000 a year to each of your children, their spouses, and any grandchildren without even using up part of your exclusion.

Consider other tax-smart ways to give

If you don't want to take the tax hit on an IRA withdrawal, there are other effective ways to give that won't have you paying more to Uncle Sam.

For instance:

  • Give an asset that has a high probability of future appreciation, such as a growth stock or real estate. You'd reduce your estate's value by the value of the gift, and avoid future appreciation that might raise your tax bill.
  • Give income-producing property to someone in a lower income tax bracket. You'd again reduce your taxable estate, and the recipient would likely pay less in taxes than you would.
  • Give proceeds from the sale of assets that have gone down in value. This way, you could take the capital loss, possibly lowering your tax bill.

Let your kids inherit your IRA

Since there is no tax benefit to gifting an IRA while you're alive, you might instead consider passing it on as part of your estate plan. If your kids inherit your traditional IRA, they get the benefit of your years of saving and you avoid the taxes. However, your kids will pay income taxes on withdrawals at their own tax rate. A Roth, on the other hand, is a great way to leave money to your heirs tax-free.

Regulations for inherited IRAs are complex, so you might want to talk to a tax advisor and share the information with your kids. In fact, no matter how you choose to structure your giving, I suggest you talk to your tax advisor and discuss the pros and cons of various scenarios. Be sure to include any charitable contributions in your discussion.

Ultimately this is all part of your estate plan. So rather than just focusing on your IRA, I'd take a step back to make sure all your decisions are working together. Then talk to your kids. Whatever you decide to give them, they'll value your open and honest communication—as well as your generosity.

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Important Disclosures

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The information provided here is for general informational purposes only and is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, consult with a qualified tax advisor, CPA, financial planner or investment manager. 

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