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Gifting Money to Pay Taxes for Roth Conversion that you will inherit in the future

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  • Gifting Money to Pay Taxes for Roth Conversion that you will inherit in the future

    I been doing some research and haven’t been able to find much information on an idea that I had. This past year my wife’s mother passed away. (My wife is an only child and will solely inherit her parent’s rather sizable estate after her father passes away.) A majority of the assets are tied up in traditional pretax retirement accounts. My wife and I are usually pushing the annual limits of the 24 percent Federal tax bracket every year and we try to avoid going to a higher tax bracket. This year, My father-in-law can still file his taxes married filing jointly. This will allow him access higher limits for each Federal tax bracket in 2020. The question I have is can my wife and I both gave the maximum gift tax exemption $15,000 per person on December 31st to my father-in-law ($30,000 total in 2020) and do the same thing on January 1, 2021 for a grand total of $60,000. He would convert $250,000 of his IRA’s to Roth’s in 2020 tax year. The money that we gave him would cover the Federal taxes on this conversion at the 24 percent tax bracket. This conversion would allow him to fully utilize the space available in the 24 percent bracket and would save us on taxes in the future when my wife will inherit this money and would have to claim it within 5 years due to the Cares Act. Thanks for the advice and thoughts to this proposal!

  • #2
    Roth IRA beneficiaries can withdraw contributions from an inherited Rothaccount at any time (in fact, they're required to). But to withdraw earnings tax-free, the account must have been open for at least five years when the original account-holder died.”

    Gifts are not linked to retirement accounts.
    Retirement conversions are not linked to gifts.

    I would hope you don’t wait to 12/31/20 and plan on 1/1/21. I would want to the clock to start as soon as possible on the conversion.
    I would want a complete clearing of each gift in 2020 and 2021.

    What I am not sure about is if he pays taxes on the conversion and passes before 5 years. Looks like earnings are taxable.
    Regarding the withdrawals options,
    https://www.investopedia.com/roth-ir...-rules-4770500
    I don’t think you will know the options until he passes.

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    • #3
      Thanks for the input. We are already starting looking at the process and discussing it with the investment advisor and accountant. I just gave the dates of Dec 31st and January 1 to show it would be in two different years. It looks like it he dies within 5 years of the conversion the earnings will be taxable rather than lump sum of $250,000 which would be converted. My goal wasn’t to save the taxes on the earnings but that would be a bonus but instead reduce the amount of money I will have to pay at a higher tax bracket when
      he passes. By converting the money to a Roth now and paying his taxes through gifting him the money, I would save $20,000 in taxes due to having to pay at a higher tax rate on that $250,000 when my wife inherits it.

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      • #4
        sounds a bit complex but maybe doable. Have the Roth IRA account opened this year though. It doesn't need to be open for 5 years exactly, it needs to be open for 5 calendar years. So if you open and get the money in there this year, the five year clock starts not in December 2020 but rather it started January 2020. It will go until January 2025 rather than Dec 2025.

        You have two things wrong in your post that suggest further education is needed to make sure you know what you're doing. First, the CARES Act says nothing about inheriting retirement accounts and there's no five year rule. What you are talking about is the SECURE Act, which passed in December 2019, and it's a 10-year rule rather than 5. She'll have 10 years to clean the account out. Given it's a Roth you're trying to get to, if you are successful it's best to hold it in the Roth for all 10 years and let it all grow since you'll take it all out tax free

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        • #5
          What if the money does not grow over the next 5 years? Maybe that is not likely but it is possible. If the market sucks then you will be prepaying taxes now on a higher amount then in the future.

          ​​​​​​There is no such thing as a free lunch.

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          • #6
            Originally posted by Lordosis View Post
            What if the money does not grow over the next 5 years? Maybe that is not likely but it is possible. If the market sucks then you will be prepaying taxes now on a higher amount then in the future.

            ​​​​​​There is no such thing as a free lunch.
            But the benefit of 10% tax differential on the amount converted is substantial. Odds are in ones favor, particularly if the money is going to be in the market anyway.

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            • #7
              Yes you can gift $15,000 per person per year.
              Last edited by Peds; 11-26-2020, 07:10 AM.

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              • #8
                Well, it might work, but it might not. That is, I think the mechanism works but not as sure about the value of doing so. There are enough moving parts that I would pass. 1. The five year issue (as with Tim I am not sure what happens to the conversion if he passes inside five years); 2. Flip side, FIL lives years longer and needs to start spending the money so your wife does not inherit as much; 3. He changes his mind, decides you’re rich, and leaves the money to charity; 4. No control over future tax brackets; 5. Besides, you can invest the $60k yourself. You have control and either make enough to pay additional taxes or have the money to spend on something other than speculative tax reduction.

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                • #9
                  Larry touched upon probably the largest risks.
                  It is not beyond a possibility that a father can outlive his daughter, need or decide to spend, or change the beneficiary of choice.
                  Facts and circumstances do change. A gift has no strings attached. That is the problem of strings for a parent “gifting” to physicians (in particular couples), the strings attached.
                  You need to be prepared that your “gift” has zero strings. This is not a loan, it is a gift. Facts and circumstances do change. Deal with that before you start “investing” in this deal.

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                  • #10
                    This is a good idea with the previously mentioned caveat that paying the taxes for FIL is a gift. While the account beneficiary may be unlikely to change, that's never a 100% certainty. I read this article a while back regarding a similar thought albeit more proactive from the older generation side: https://www.forbes.com/sites/leonlab...h=33034f0d39fb
                    My father had actually been doing this for many years to to the top of the 2nd lowest tax bracket. When he passed almost 2 years ago, my mom received his IRAs that were over 80% Roth. I will inherit a portion of this and I am glad that the bulk is Roth.

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                    • #11
                      Originally posted by GasFIRE View Post
                      This is a good idea with the previously mentioned caveat that paying the taxes for FIL is a gift. While the account beneficiary may be unlikely to change, that's never a 100% certainty. I read this article a while back regarding a similar thought albeit more proactive from the older generation side: https://www.forbes.com/sites/leonlab...h=33034f0d39fb
                      My father had actually been doing this for many years to to the top of the 2nd lowest tax bracket. When he passed almost 2 years ago, my mom received his IRAs that were over 80% Roth. I will inherit a portion of this and I am glad that the bulk is Roth.
                      Sure, but their decision, and taxes out of their pocket, right? You are not paying for the conversions? In that scenario, I agree it was a good thing for your parents to do.

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                      • #12
                        Originally posted by Larry Ragman View Post

                        Sure, but their decision, and taxes out of their pocket, right? You are not paying for the conversions? In that scenario, I agree it was a good thing for your parents to do.
                        I definitely appreciate my father’s financial wisdom, he did this to optimize the estate for his family. OP is in a similar situation but would have to put up their own $60K. It’s a good bet if things go as expected, wife inherits FIL’s “rather sizable estate”. It’s a bad bet under some of the conditions you described in your previous post. Only OP and family are in a position to assess the likelihood of these potential outcomes. OP has $60K available to invest. While this is an illiquid investment, the potential is there for a significant positive return.

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                        • #13
                          Not a darn thing wrong with it.
                          It just might not pan out. Any gift with any intent might not, either. This looks promising, actually better than chipping in later. Some folks actually welcome input on estate planning preferences.

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                          • #14
                            I want to thank everyone for there advice and recommendations. This idea is a little out of the box and I realize with any investment there are risks. It is possible the circumstances could change with the greatest risks which would include: having beneficiaries change, a large unforeseen financial event, decreased Federal tax rates in future, changes in tax law concerning Roth’s, or runaway inflation. This $250,000 is a small part of his net worth, which is why I am considering such a drastic measure because there is no way I will be able to spread this amount over 10 years without going to another tax bracket every year. What I was mostly concerned about is what I am proposing legal? It has been a very difficult transition for him loosing his wife and she took care of all the financial affairs prior to her passing and he is completely lost as he didn’t even know how to fill out a bank deposit slip after she died. At the same time, he resents the government and doesn’t want to pay a cent more to the government in taxes. I appreciate the input of the five year aspect of possibly having to pay taxes on the income if he passes within 5 years of the conversion. This is something I didn’t consider. On the other hand I am looking at possibly saving a minimum of 20k and possibly more with the tax free investment income on the $250,000 if he lives longer than 5 years in future taxes by gifting the money now so he pays the additional taxes on this conversion rather than having pay the taxes at a higher tax bracket when he dies.

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                            • #15
                              I am not a lawyer or CPA. Sounds like a fine plan to me. Gifting money is not illegal.

                              you said “a majority is in pretax” what about the rest? Is there any in Roth already?

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