If you’ve managed to sock away more money than you’ll need to fund your retirement, it’s only natural to start considering ways to pass on your wealth to your heirs while forking over the smallest amount of taxes as possible. Gifting retirement assets to sons and daughters may help avoid a tax hit, but only in some circumstances, as you’ll be negotiating overlapping bits of retirement account, gift and estate tax law.
The Internal Revenue Service allows you to give up to $13,000 per year to as many people as you choose without incurring the gift tax. If you’re married, you and spouse may each give away $13,000 annually to as many people as you like. So, for example, each of you could give $13,000 every year to both your daughter and her husband, resulting in net annual gifts of $52,000. Gifting money to heirs can be a strategy to avoid estate taxes, as it allows you to slowly pass money to heirs before you die. The entire value of your estate at the time of your death is subject to the estate tax.
Gifting from IRAs
If you’re looking to pass money directly from your IRA to a son or daughter, you’re out of luck, at least during your lifetime. Because you made contributions to your IRA on a pre-tax basis, the IRS requires you to pay ordinary income taxes when you pull money out of your account. Only you can make withdrawals. After you receive your retirement funds from your IRA, you may then give them to your heirs, navigating gift tax laws. This strategy, however, won’t reduce your income taxes.
When you die, before your estate is divided between your heirs it may need to pay the IRS before your worldly goods go to your heirs. As of 2013, the first $1 million of your estate is exempt from taxes. Beyond that exemption, your estate is taxed at a 55 percent rate. For example, if your estate is valued at $2 million, the first $1 million will be exempt from taxes, but you’ll pay $550,000 on the second $1 million. Your heirs will receive $1.45 million to divvy up among themselves. Because of this, you’ll need to slowly gift retirement savings to heirs in order to avoid a hefty estate tax bill.
The IRS allows you to name a beneficiary to each of your IRA and Roth IRA accounts. If you haven’t exhausted the funds by the time you die, probate is avoided and the remaining funds immediately become property of the beneficiary. The account’s value is still used when the IRS determines the value of your estate for estate taxes. However, this maneuver avoids any “double taxation” you may incur by taking a distribution from your IRA, paying income taxes on it, then subjecting it to estate taxes when you die.