Grandparents may be tempted to leave an Individual Retirement Account (IRA) to a grandchild because children have a low tax rate, but the “kiddie tax” could make doing this less beneficial.
An IRA can be a great gift for a grandchild. A young person who inherits an IRA has to take minimum distributions, but because the distributions are based on the beneficiary’s life expectancy, grandchildren’s distributions will be small and allow the IRA to continue to grow. In addition, children are taxed at a lower rate than adults—usually 10 percent. See our analysis of who should be the beneficiary of your IRA.
However, the lower tax rate does not apply to all unearned income. Enacted to prevent parents from lowering their tax burden by shifting investment (unearned) income to children, the so-called “kiddie tax” allows some of a child’s investment income to be taxed at the parent’s rate. For 2017, the first $1,050 of unearned income is tax-free, and the next $1,050 is taxed at the child’s rate. Any additional income is taxed at the parent’s rate, which could be as high as 35 percent. The kiddie tax applies to individuals under age 18, individuals who are age 18 and have earned income that is less than or equal to half their support for the year, and individuals who are age 19 to 23 and full-time students.
If a grandparent leaves an IRA to a grandchild, according to the Internal Revenue Code, the grandchild must begin taking required minimum distributions within a year after the grandparent dies. These distributions are unearned income that will be taxed at the parent’s rate if the child receives more than $2,100 of income (in 2017). In addition to IRAs, the kiddie tax applies to other investments that supply income, such as cash, stocks, bonds, mutual funds, and real estate.
If grandparents want to leave investments to their grandchildren, usually they are better off leaving investments that appreciate in value, but don’t supply income until the investment is sold, or perhaps refinanced. Grandparents can also leave grandchildren a Roth IRA because the distributions are tax-free.
For more information about leaving an IRA to grandchildren from Kiplinger, click here. For more information about using a trust for control and protection of the IRA for a grandchild, see our post entitled: Using Trust to Protect Inherited IRAs
If you would like to meet with us to determine how to most efficiently transfer your IRAs or other assets to your children or grandchildren, please call and schedule an appointment. Proper distribution planning can help ensure that your intended beneficiaries get to actually enjoy and appreciate their inheritance from you.