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Commentary: What you need to know when gifting your kids money for an IRA

Parents want to give their children all the help they can, and if they have the wherewithal to improve their kids' financial standing, they often do so.

Parents want to give their children all the help they can, and if they have the wherewithal to improve their kids' financial standing, they often do so.

One great idea that we've used with many of our clients is gifting money to their children to fund a Roth IRA.

The rules surrounding the IRS's gift tax regulations as well as the rules surrounding Roth IRA contributions can produce a lot of questions. To help resolve any confusion you may have, here's what you need to know if you're thinking about gifting money to your children so that they can contribute to a Roth IRA.

Overview of Gift Tax Rules

Before diving into the idea of gifting money to your children-or anyone for that matter-it's import to first outline the rules surrounding gifts from a tax perspective. For 2017, the gift tax exclusion is $14,000. This $14,000 means that you can gift up to that amount of money to an individual without any gift tax implications. Therefore, if you have three children, you can gift each child $14,000 ($42,000 in total) without any negative consequences. If you're married, you and your spouse can each gift $14,000 to someone, thereby allowing you to gift $28,000 per person as a couple.

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You may be asking yourself what happens if you exceed the annual gift exclusion. The answer is you'll need to report that gift with the IRS, but there are likely to be no lasting tax consequences for you. The reason is that each person has a lifetime gift exclusion of $5.49 million, and that number increases over time.

Let's say you're single and want to gift your child $25,000 this year so they can put together enough money for a down payment on a house. Because you exceeded the annual gift tax exclusion by $11,000, you would have to report that with the IRS; you wouldn't have to pay any taxes on that $11,000. All that would likely happen is that your lifetime gift tax exclusion (the $5.49 million we referenced earlier) would be reduced by $11,000. No significant tax consequences would come into play until you've used up your $5.49 million lifetime gift tax exclusion.

How to Turn a Gift into a Roth IRA Contribution

The best thing about gifting is that if you're gifting loved ones after-tax money, they won't

have any tax implications. In other words, if you gift a child $14,000, they won't have to include that money in their taxable income.

In order for the gifted money to truly be a gift, you can't dictate how the recipient uses that money (although you can strongly recommend a specific purpose to the recipient). It's up to the recipient to make the final decision how that money may be used-including investing in a Roth IRA.

To be eligible to contribute to an IRA, you must have taxable compensation equal to the amount you contribute, up to a maximum of $5,500 ($6,500 if age 50 or older). This means that if you're gifting money to your child and they only earn $2,500, they can only contribute up to $2,500 to an IRA that year.

We like to refer to Roth IRAs as a gift from the IRS. The advantage of tax-free growth over long periods of time in addition to tax-free income in retirement can be incredibly powerful. Helping your children utilize this strategy while they are young by gifting them money is a great way to help get them off on the right when it comes to saving for the future.

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Bruce Helmer and Peg Webb are financial advisers at Wealth Enhancement Group and co-hosts of "Your Money" on KLKS 100.1 FM on Sunday mornings. Email Bruce and Peg at yourmoney@wealthenhancement.com . Securities offered through LPL Financial, member FINRA/SIPC. Advisory services offered through Wealth Enhancement Advisory Services, LLC, a registered investment adviser. Wealth Enhancement Group and Wealth Enhancement Advisory Services are separate entities from LPL Financial.

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